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In order to clarify difficult problems the Tax Institute conducts 
panel discussions by informed persons representing different points of 
view. The publication of this volume carries with it, of course, no en- 
dorsement of the views — sometimes conflicting — of the various par- 


Kenneth Perry, President 

Dan Throop Smith, First Vice President 

C. Emory Glander, Second Vice President 

Herbert M. Kelton, Treasurer 

Mabel L. Walker, Executive Director 


Weston Vernon, Jr. K. M. Williamson 

Robert S. Ford H. M. Robertson 

Alan L. Gornick John F. Sly 

Preceding Presidents 
J. K. Lasser Alfred G. Buehler 

Economic Effects of Section 102 

The Penalty Tax on Unreasonable Accumulation of Profits 


Alfred G. Buehler, Chairman of Panel Committee, 1949 
Weston Vernon, Jr., Chairman of Panel Committee, 1950-51 

Edwin B. George, Chairman of Fact-Finding Panel and Policy Panel 

Kossuth M. Williamson, Consultant 

Mabel L. Walker, Editor 


457 Nassau Street, Princeton, New Jersey 



Alfred G. Buehler, Chairman 
Frederick L. Bird Alvin A. Burger 

Philip Cortney Robert S. Ford 

Joseph D. Hughes J- K. Lasser 

Kenneth Perry Weston Vernon, Jr. 

K. M. Williamson 


Weston Vernon, Jr., Chairman 
Maurice Austin Alfred G. Buehler J. K. Lasser 

* * * 


Economists, tax practitioners, and taxpayers for many years have 
debated as to the effect of the sections of the federal income tax law 
which penalize unreasonable accumulations of surplus by the impo- 
sition of a surtax upon undistributed income. 

The Tax Institute has undertaken the work of assembling some ma- 
terial of real worth with respect to the actual operation of Section 102. 
This was done through a questionnaire sent to a large number of tax 
practitioners and others who might have direct information as to the 
workings of the section. Thereafter, all phases of the matter were dis- 
cussed by a panel of eminent experts. Subsequently, another panel of 
tax authorities discussed possible revisions of the law and made certain 
recommendations in this connection. 

The study contained in this volume was inaugurated in 1949 when 
Mr. J. K. Lasser was president of the Tax Institute and under the 
panel chairmanship of Professor Alfred G. Buehler. It was carried for- 
ward in 1950 when Professor Buehler was president. Each of them con- 
tributed much to the success of the survey. 

Needless to say, the Tax Institute, as a true research institution, 
takes no position with respect to the advisability of retaining Section 
102 in the law or the necessity of amendatory legislation. This we leave 
to others. Rather, the function of the Institute has been to assemble 
facts and competent opinions on the actual working and operation of 
this portion of the tax law for the benefit of those who advocate 
changes or whose duty it is to consider the operation of the tax laws. 

The Institute acknowledges, with gratitude, the help of all those 
who answered the questionnaire, and who participated in the panel 
discussions, thus making possible the publication of this volume. 

Weston Vernon, Jr. 

Panel Committee 
New York 
June, 1951 



Foreword by Weston Vernon, Jr., Milbank, Tweed, Hope & Hadley v 

Synopsis of Questionnaire Survey and Panel Discussions ix 

i. Preliminary Statement 

Preliminary Statement by Allan F. Ayers, Jr., Hodges, Reavis, Panta- 

leoni & Downey 3 

2. Questionnaire Survey 

Questionnaire Survey 7 

3. Fact-Finding Panel on Economic Effects 

Introduction by Alfred G. Buehler, University of Pennsylvania ... 28 
Statement of Panel Function and Procedure by Edwin B. George, Di- 
rector, Department of Economics, Dun & Bradstreet, Inc 29 

Discussion of Panel Procedure 33 

Statement by Maurice Austin, Klein, Hinds & Finke 37 

Discussion of Statement by Maurice Austin 41 

Statement by Norman D. Cann, Cann and Long 43 

Discussion of Statement by Norman D. Cann 50 

Statement by George Sibley, General Counsel, E. R. Squibb & Sons . . 52 

Discussion of Statement by George Sibley 55 

Statement by Harry J. Rudick, Lord, Day & Lord 58 

Discussion of Statement by Harry J. Rudick 61 

Statement by Clarence L. Turner, Turner, Crook & Zebley .... 64 

Discussion of Statement by Clarence L. Turner 67 

Statement by Walter Cooper, Peat Marwick Mitchell & Company ... 70 

Discussion of Statement by Walter Cooper 78 

Statement by Harold P. Kurzman, President, Lily of France, Inc. ... 79 

Discussion of Statement by Harold P. Kurzman ........ 81 

Statement by Joseph S. Piatt, Porter, Stanley, Treffinger & Piatt ... 83 

Discussion of Statement by Joseph S. Piatt 88 

Statement by S. Abbot Smith, President, Thomas Strahan Company . . 91 

Discussion of Statement by S. Abbot Smith 96 

Statement by Paul Mickey, Steptoe & Johnson 97 

Discussion of Statement by Paul Mickey 100 

Statement by Vincent H. Maloney, Alvord & Alvord 102 

Discussion of Statement by Vincent H. Maloney 105 

Statement by Allan F. Ayers, Jr., Hodges, Reavis, Pantaleoni & Downey 108 

Discussion of Statement by Allan F. Ayers, Jr. , 113 




Statement by Albert Dixon, Jr., Hadfield, Rothwell, Soule & Coates . . . 122 

Discussion of Statement by Albert Dixon, Jr 126 

Statement by Harry Silverson, Silverson k Allison 134 

Discussion of Statement by Harry Silverson 137 

Statement by Robert N. Miller, Miller & Chevalier 142 

Discussion of Statement by Robert N. Miller 149 

Statement by Dan Throop Smith, Harvard University 164 

Discussion of Statement by Dan Throop Smith 167 

Concluding Discussion of Questions to be Referred to Policy Panel . .170 

4. Summary Comment on Fact-Finding Panel 

Summary Comment by K. M. Williamson, Wesleyan University . . .178 

5. Policy Discussion Panel 

Introductory Statement by Edwin B. George, Director, Department of 

Economics, Dun & Bradstreet, Inc 187 

Statement by William J. Duiker, Montgomery, McCracken, Walker & 

Rhoads *97 

Discussion of Statement by William J. Duiker 203 

Statement by Alan L. Gornick, Director of Tax Affairs, Ford Motor 

Company 206 

Discussion of Statement by Alan L. Gornick 209 

Statement by Mark E. Richardson, Lybrand, Ross Brothers & Mont- 
gomery 210 

Discussion of Statement by Mark E. Richardson 213 

Statement by John L. Connolly, Secretary, Minnesota Mining Sc Manu- 
facturing Company 217 

Discussion of Statement by John L. Connolly 218 

Statement by Martin R. Gainsbrugh, Chief Economist, National Indus- 
trial Conference Board 222 

Discussion of Statement by Martin R. Gainsbrugh 22,6 

Statement by Richard E. Slitor, Assistant Director, Tax Advisory Staff 

of the Secretary of the Treasury 231 

Discussion of Statement by Richard E. Slitor 232 

Statement by L. H. Sonderman, Tax Manager, Hamischfeger Corpora- 
tion 237 

Discussion of Statement by L. H. Sonderman 240 

Statement by William Vickrey, Columbia University 242 

Discussion of Statement by William Vickrey 246 

Statement by Maurice Austin, Klein, Hinds & Finke 255 

Discussion of Statement by Maurice Austin 257 

Formulation of Policy Panel Recommendations 262 

Kenneth W. Gemmill, Barnes, Dechert, Price, Myers & Clark, also participated 
in the panel, but waived the privilege of making a specific statement. 
# * # # # 

Bibliography 3° 2 

Index 3°9 

Synopsis of Questionnaire Survey 
and Panel Discussions 

Outline of Synopsis 

A. Impact Upon Individual Business Enterprises 
i. Discriminatory Impact 

a. Upon Small Business 

b. Upon Closely Held Corporations 

c. Upon Corporations with Highly Variable Earnings 

2. Fear and Uncertainty 

3. Forcing Dividends 

4. Results of Forcing Dividends 

a. Expansion Retarded 

b. Borrowing Increased 

c. Operations Curtailed 

d. Provision for Contingencies Prevented 

5. Business Practices Resulting from Attempts to Avoid Distribution 

a. Premature or Unwise Expansion 

b. Change of Business Form 

c. Debt Reduction 

d. Debt Rather Than Equity Financing 

e. Creation of Nonliquidity 

f. Miscellaneous Business Practices 

6. Deterrent to Funding Depreciation 

7. Harmful Publicity 

8. Sales, Mergers, or Liquidations of Business Enterprises 

9. Combined Effect of Section 102 and Estate and Capital Gains Taxes 
10. Cyclical Variations in Impact of Tax 

B. Characteristics of Provision and Its Administration That 
Accentuate Undesirable Results 

1. Immediacy Doctrine and Difficulties of Foreseeing Future 

2. Nonuniformity of Administration 

3. Use of 102 as a Threat 

4. Administrative Lack of Familiarity with Corporate Problems 

5. Once Set Up, Always Checked 

6. Seventy Per Cent Rule 

7. Delay in Final Decisions 

8. Burden of Proof 

9. Test of Intent 

10. Harmful Publicity 

11. Court-made Law 

12. Directors' Liability 

13. Weapon for Socialistic Planners 



C. Resulting Impact Upon Economy 
i. Effect Upon Concentration of Business Enterprise 

2. Accentuation of Inflationary and Deflationary Trends 

3. Weakening Enterprise Through Overdistribution and Resultant Inability to 
Meet Capital Requirements 

4. Shift from Equity to Debt Financing 

5. Shift from Local to Foreign Enterprise 

6. Retardation of Business Growth 

7. Impediment to Job Creation 


A. Necessary Part of Income Tax Law 

B. Reasonable and Fair Interpretation of Law 

C. Causes Year-end Appraisal and Long-Term Program by Management 



A. Procedural Changes 

1. Clarity 

a. Stipulation of Conditions for Retention 

b. Campaign of Education 

c. Clarification of Extent of Personal Liability of Directors 

2. Internal Review 

3. Timing 

B. Criteria for Legislative and Administrative Rules 

1. Limitation of Area of Challenge 

a. By Type of Corporation 

b. By Exemption of Percentage of Accumulation in One Year 

c. By Exemption of a Percentage of Accumulation Within Three or More Years 

d. By Exemption of Specified Amount of Earnings 

e. By Reduction of Penalty Rate 

f. By Application of Penalty Only to Unreasonable Part of Accumulation 

2. Evidence 

a. Timing 

b. Purpose of Investment 

C. Burden of Proof 

D. Deficiency Dividend Credit 

E. Presumption of Reasonable Accumulation 

F. Miscellaneous Proposals 




The panel discussion serves to illuminate and supplement the findings from 
the questionnaire survey. The results of the questionnaire were not made 
available to the participants in the fact-finding panel, yet repeatedly the 
panel statements served to clarify and point up the data contained in the 

It is interesting to note that some of the most emphasized points that 
emerged from the combined methods of investigation, for example, with re- 
spect to concentration of business enterprise, accentuation of the business 
cycle, and discrimination against small enterprises, had not been foreseen 
and were not touched upon in the questionnaire. 

A. Impact Upon Individual Business Enterprises 

i. Discriminatory Impact 

a. upon small business 

The point that Section 102 discriminates against small business enterprises was 
referred to by several fact-finding panel participants: Austin (39, 40, 94); Sibley (52); 
Turner (67); Kurzman (79, 80); S. A. Smith (92, 93, 94, 95, 100, 101, 106, 149); 
Maloney (102, 103, 104, 105); Ayers (114-15); Cann (128); and Cooper (116, 140, 
159). See also questionnaire (14, 15). 

Some of the reasons given were that since small businesses have difficulty in get- 
ting capital (both by equity financing and debt), they grow by retaining their 
earnings. Also they need more earnings because they have more frequent ups and 
downs. Long range accumulation is necessary. They need to retain earnings in the 
form of free cash reserves, because opportunities come suddenly and unexpectedly 
and because they must protect themselves against unknown future contingencies. 
It is harder for the small business to justify its retentions because its needs may be 
less obvious. The small businessman is less likely to have good tax advice. He is 
also less likely to fight in court. Small businessmen are more emotional and less 
informed and more likely to get panicky. 

Dixon stated, however, that he did not know of a single case where a small 
corporation had not been able to retain a large proportion of its earnings "if it was 
in a proper reasonable expansion program." 

Discrimination against small business was re-emphasized in the policy panel dis- 
cussion by Duiker (201-2); Gainsbrugh (224-25); Gornick (229-30); and Sonderman 


Slitor inquired whether "a small business should be concerned about the appli- 
cation of Section 102 if it diverts its retained earnings into the expansion of its 
plant, into normal growth" (225). 

b. upon closely held corporations 

That the particular impact of the penalty provision is upon closely held corpora- 
tions was frequently repeated both in the questionnaire replies and in the panel 
discussions. There was no disposition to dispute this claim. 

There was general agreement in this connection to the effect that it is not enough 
to know the number of stockholders. It is also necessary to know something about 
the distribution of the stock (35-37). 

Piatt expressed doubt that widely held corporations were influenced by 102, 
but he included among closely held the type in which the corporation is dominated 


by a small group or family, even though the stock is widely held (84). Miller 
felt that widely held companies did consider 102 (15). Widely held corporations 
sometimes raise a question as to whether 102 has any reference to accumulations 
by subsidiaries; Piatt (84). The questionnaire returns indicated that in one or two 
isolated cases Section 102 had prompted the parent company to have the subsidiary 
pay a dividend to the parent corporation, which was the only stockholder (15). 
Reference was made to the same point by Ayers in the panel discussion (112-13). 
See also questionnaire (14). 

Judging retentions of privately held companies by comparison with actions of 
publicly held competitors would not be upheld: Silverson, Maloney, and Cann (139- 


The particular vulnerability of corporations with variable earnings was com- 
mented upon by Austin (42), Turner (42), Kurzman (80), and S. A. Smith (101). 
Other groups particularly vulnerable were enumerated by Austin (39-40). See also 
questionnaire (12-14). 

2. Fear and Uncertainty 

The fear and uncertainty occasioned by 102 were repeatedly emphasized in the 
fact-finding panel: Austin (39, 40, 43, 63, 106); Cann (114, 117); George (69); 
Cooper (73); Kurzman (80); S. A. Smith (91, 92, 95, 96); Ayers (110-11, 117-18); 
Rudick (115); and Miller (118, 143). 

Fear and uncertainty were again emphasized in the policy panel discussion by 
Austin (204, 215); Duiker (202); Gainsbrugh (216, 222-23, 226 > 22 8)> George (215); 
Gornick (206-9, 216, 229-31); Richardson (211-12, 213-15, 227); and Sonderman 

( 2 37)- 

Some of the participants felt that fear arose through ignorance: Rudick (60-61); 
Piatt (84); Dixon (124-25, 155); and S. A. Smith (92). Mr. Dixon felt that more 
education on the part of the practitioners was needed so that they wouldn't be 
accelerating the nebulous fears of the businessman (126). 

Miller, on the other hand, disagreed with this view and expressed the view 
that the anxieties of many taxpayers "are not due to ignorance, but to knowledge 
as to how governments act when powers of penalizing taxpayers are phrased in 
such general language, and when political issues are involved" (143). 

Slitor pointed out that "uncertainty is an inherent part of a provision of law 
which is designed to function flexibly" (214). 

Rudick (61) and Duiker (209-10) felt that certainty was impossible. 

3. Forcing Dividends 

An overwhelming majority of the questionnaire respondents indicated that 
consideration was given to Section 102 in making distributions by at least some of 
their clients. Practitioners differ as to the extent to which Section 102 forces divi- 
dend distributions that would not otherwise take place. Judging by the question- 
naire replies, it appears that the average respondent thought that Section 102 was 
a controlling factor in dividend distributions for almost 20 per cent of his clients; 
that it was a contributing factor for approximately 40 per cent; and was inconse- 
quential for the remaining 40 per cent. 

Austin pointed out in the panel that a practitioner's experience would be rather 
deceptive in this respect since his greatest experience would be with those clients 
who are in trouble or think they are in trouble. He estimated that in his experi- 
ence increased dividends, or some alternate action, was necessary in only about 
10 per cent of the cases (41). Cann stated that in his experience not more than 
5 per cent paid dividends which otherwise wouldn't have been paid (49). Other 
instances of forcing dividends were given by Turner (64-65); Piatt (84); S. A. Smith 
(92); Maloney (102-3); Ayers (112); and Dixon (124). 


On the other hand, there was considerable testimony both in the panel and the 
questionnaire that profits were frequently retained in spite of worrying over 102 and 
in some cases in spite of being vulnerable: Sibley (42); Austin (42); S. A. Smith 
(92, 93, 95, 96); Piatt (115); Ayers (114); Rudick (60, 115); and questionnaire 

The high surtax rates cause dominant stockholders to try to find ways of avoiding 
dividends: Maloney (102, 103); questionnaire (17-19, 24). 

Maloney suggested that it would be helpful to have a statistical study, comparing 
the percentage of income distributed by a representative group of widely held 
corporations with that distributed by a group of personal service, brokerage, and 
other corporations affected by 102. He also suggested that there might be value 
in a study comparing distributions from 1900 to 1913 when there was no income 
tax problem with distributions from 1930 to 1945 (103). 

Further references to the forcing of dividends were made in the policy panel 
discussion by Connolly (218); and George (215). 

4. Results of Forcing Dividends 


Austin pointed out that the section has a dampening effect on business activity 
and growth (39, 41). Testimony concerning curtailment of expansion as a result of 
forced dividends or imposition of penalty was also given: Cooper (75, 76-77, 79); 
and Dixon (123-24). Rudick commented that he did not see why 102 should pre- 
vent growth and expansion of plant and equipment (58-59). There was a great 
deal of testimony concerning the particular hardship in this connection imposed 
upon small business by the "immediacy" doctrine. See references under Immediacy 
Doctrine and Difficulties of Foreseeing Future. 

The questionnaire replies indicated that plant expansion and acquisition of new 
machinery were more frequently stimulated than retarded by 102. On the other 
hand, product development was retarded somewhat more than it was stimulated 
(19). See also Premature or Unwise Expansion below. 


Questionnaire respondents indicated that increased borrowing both from stock- 
holders and from banks had resulted from the forcing of dividends (18, 19, 20). 
Increased borrowing was referred to by some of the panel participants: Austin (38, 
39); Turner (66). See also references under Debt Rather Than Equity Financing. 


Eleven questionnaire respondents indicated that operations were frequently cur- 
tailed and twenty-four that they were infrequently curtailed as a result of the 
forcing of dividends: Duiker (202). 


Inability, particularly upon the part of the small businessman, to provide for 
contingencies, appeared to be one of the effects that troubled the panel partici- 
pants most in connection with 102. Kurzman (80, 81) and S. A. Smith (100) as 
representatives of small business mentioned this feelingly, and Cann (51), Sibley 
(52, 53, 132), and Ayers (109-10) also commented upon this effect. 

5. Business Practices Resulting from Attempts to Avoid Distribution 


Professor D. T. Smith commented in the panel discussion that: "On balance, my 
own observations and inquiries on this suggest that perhaps there has been some- 
what more total capital investment, even in the long run, as a result of Section 102. 
This is in spite of the fact that for a fair number of companies, because they 
choose not to do things presently and do make greater dividend distributions, they, 
in the long run, may not do quite so much as they otherwise would" (166). 


In substantiation of Professor Smith's thesis both the questionnaire and panels 
appear to yield more data concerning forced or accelerated expansion than curtail- 
ment of expansion as a result of Section 102. This, however, may only be true 
in a period of substantial profits. 

There was discussion of additional or speeded up expansion (including develop- 
ment of products) resulting from 102 by the following panel participants: Cann 
(45-46); Rudick (59); Turner (65, 66, 67, 68); Cooper (74, 76-77); Piatt (86-87); 
Maloney (104-5); an d general discussion (88-91). 

In the questionnaire survey eighty-five practitioners reported evidences of stim- 
ulation, either frequent or infrequent, whereas thirty- two reported evidences of 
retardation, either frequent or infrequent. Almost four times as many question- 
naire respondents indicated that expansion was frequently stimulated as that it 
was frequently retarded. Eleven practitioners saw diverse effects upon different 
clients. With respect to the development of new products, however, the evidence 
seemed to be greater with respect to retardation than stimulus (19-21). Mr. Duiker 
referred to the precipitation of hasty expansion in policy panel (202). 

Professor Smith commented further that perhaps of equal importance with the 
volume of expansion is the "matter of who is doing the expanding" (166). The 
question of whether the expansion resulting from 102 might be on the part of 
relatively large companies that were in a position to go ahead at once rather than 
the very small companies that had to save over a longer period for expansion 
projects seemed to underlie some of the discussion: Austin (39); Sibley (52); 
Turner (68); and Maloney (105-6). 


There has been some evidence of the conversion of corporations into partnerships, 
particularly in the case of new corporations coming into being with the repeal of 
the excess profits tax: Austin (38); and Duiker (202). 

Sixty-one questionnaire respondents reported that clients had changed from cor- 
porate to partnership or sole proprietorship form of enterprise (19). 


Sixty-seven questionnaire respondents reported that clients had reduced debt as a 
result of 102 (18). 


Fifty-two questionnaire respondents reported that clients had shown a prefer- 
ence for debt rather than equity financing as a result of 102 (19). See also Austin 
(38-39), Cann (48), Rudick (58), Turner (66), Cooper (76), D. T. Smith (167), 
general discussion (163-64), and Duiker (202). 


Austin considered the practice of creating nonliquidity on balance sheets at 
the end of the year as among the widest effects of the provision, "although per- 
haps not the most important" (38); questionnaire (21). 


Among the miscellaneous business practices resorted to were mentioned the 
placing of questionable orders: Austin (38); excess buying of raw materials, Cann 
(45, 49); inventory accumulation, Cann (44), Duiker (202), Kurzman (81) and 
questionnaire (19); deferred collections, Cann (49), Kurzman (81); keeping funds 
uninvested, Rudick (59-60); increased perquisites for personnel, S. A. Smith (95); 
bonus and salary increases, Piatt (85-86), S. A. Smith (159), and questionnaire 
(18-19); stock dividends, Cann (45); labor furloughed, questionnaire (19); apathetic 
attitude toward increased costs, questionnaire (21); chronic desuetude, question- 
naire (19); unwise acquisition of assets, Duiker (202); pension and profit-sharing 
plans, Duiker (202). 

Rudick commented that he thought these various window-dressing devices were 


resorted to considerably at the end of 1946 and 1947, but that they have been 
reduced and are gradually disappearing (59). Piatt stated that he had never seen 
anything of these window-dressing devices (86). 

6. Deterrent to Funding Depreciation 
Cann was of the opinion that Section 102 acted as a deterrent to funding de- 
preciation (47). See also Dixon (130-31) and statement by Paul F. Myers quoted 
in footnote (47-48). 

7. Harmful Publicity 
The danger of harmful publicity and the consequent reluctance of corporations 
to take their cases to court was pointed out by Silverson (135-36), and Miller stated 
that "the mere assertion by a revenue agent . . . though ill-advised and unfounded, 
may do ... a corporation harm, even though there is no litigation about the 
tax" (144). See also D. T. Smith (165). 

8. Sales, Mergers, or Liquidations of Business Enterprises 
A much emphasized point related to the effect of the provision in bringing about 
sales or liquidations of business enterprises. This was commented upon by the 
following panel participants: Austin (38), Cann (46-47, 50), Sibley (55), Turner 
(56, 67), Rudick (59), Piatt (87), Mickey (97), Maloney (105), Ayers (112), and 
Duiker (202). There seemed no disposition to dispute claims concerning this effect. 
Thirty-eight questionnaire respondents indicated that 102 had stimulated merg- 
ers on the part of their clients and thirty-one reported that it had brought about 
cases of complete liquidation and discontinuance of the business. Some comments 
and case histories were also furnished in this connection (21-23). 

9. Combined Effect of Section 102 and Estate and Capital Gains Taxes 
The interrelationship of other taxes with Section 102 in bringing about certain 
effects was noted by panel participants and questionnaire respondents: Ayers (55), 
Turner (55), Cooper (77), and Silverson (134). Similar references are found in the 
questionnaire (23). 

10. Cyclical Variations in Impact of Tax 
Some of the panel participants pointed out that the effect of 102 varies with 
business conditions. Relatively little was heard about it before the war: Austin 
(39), S. A. Smith (83), Dixon (122-23, i*9-3°)» and questionnaire (15). 

B. Characteristics of Provision and Its Administration That 
Accentuate Undesirable Results 
A number of panel participants commented on the generally fair and reasonable 
attitude of the Bureau and the Tax Court in Administering and interpreting 
Section 102. References are given under Reasonable and Fair Interpretation of Law. 
Nevertheless, some of the specific characteristics of the provision and its adminis- 
tration were criticized. 

1. Immediacy Doctrine and Difficulties of Foreseeing Future 
The doctrine of justifying retentions only on the basis of requirement for im- 
mediate needs, which the courts appear to be building up, constitutes a great 
handicap for businessmen and this is accentuated by difficulties in foreseeing future 
needs: Austin (40, 63), Cann (51), George (63, 133), Cooper (73-74). Maloney 
(104-5), platt ( l 33)> Sibley (133-34), Silverson (166-69), S. A. Smith (83, 169), and 
questionnaire summary (24). Policy panel: Austin (203, 256, 257-58, 261), Connolly 
(257), Duiker (259), and Sonderman (258). 

On the other hand, Rudick expressed the opinion that "if the Tax Court were 
persuaded that the owners were really withholding distribution for future purposes 
which were real , , , the decision would probably be in their favor." 


2. Nonuniformity of Administration 

Various comments were made respecting the nonuniformity of administration 
with respect to Section 102. The following particular points were brought out: 

Real or possible shifts in Bureau attitudes: Austin (39, 42), S. A. Smith (95), 
Miller (145), Cann (152), and questionnaire (26). 

Divergence between Bureau and revenue agent attitudes: Cooper (73). Policy 
panel: Richardson (227), and Sonderman (227). 

Variations in attitudes of revenue agents, by areas and within same district: 
Ayers (108, 121), Silverson (135), Cann (151), Dixon (151), and questionnaire (26). 

3. Use of 102 as Threat 
Dixon (125), Miller (120), questionnaire (25), Richardson (212, 214-15), D. T. 
Smith (88), Sonderman (240), and unidentified speaker (242). 

4. Administrative Lack of Familiarity with Corporation Problems 
Miller (144), and Richardson (210-11, 227). Administration mechanical rather 
than factual: Sonderman (240). 

5. Once Set Up, Always Checked 
Silverson (135), questionnaire (26). Policy panel: Austin (242), Duiker (241-42), 
and Gornick (208-9). 

6. 70 Per Cent Rule 
Austin (39), Cann (44, 121), Ayers (108-9), Dixon (120), and questionnaire (26). 

7. Delay in Final Decisions 
Austin (41), and Cann (141). 

8. Burden of Proof 
Turner (64), Ayers (122), Dixon (125), and Rudick (132). Rudick was, however, 
somewhat dubious concerning the desirability of shifting the burden of proof. 

9. Test of Intent 
Rudick (138), Maloney (138), Cooper (138), and Cann (140). 

10. Harmful Publicity 
Silverson (135-36), Miller (143), and Cann (152). 

11. Court-made Law 
Cann (118), and Ayers (118-19). 

12. Directors' Liability 
Cooper (50), Kurzman (50), Maloney (107), Ayers (111-12), Rudick (115,119,174), 
Cann (117), Dixon (119, 174), Silverson (119), and Prerau (174). 

13. Weapon for Socialistic Planners 
Sibley (53). 

C. Resulting Impact Upon Economy 
1. Effect Upon Concentration of Business Enterprise 
Some of the most emphatic testimony given in both the panel discussion and 
the questionnaire responses related to the effect of Section 102 upon the concen- 
tration of business enterprise. This was repeatedly emphasized. Apparently the 
section tends to produce this effect in two ways: First, by making it difficult for 
small business to retain adequate reserves for contingencies and for expansion, and 
second, because taken in conjunction with other taxes, it tends to bring about 
mergers, sales, and liquidations. See in this connection the references cited under 
Discriminatory Impact Upon Small Business and under Sales or Liquidations. 


2. Accentuation of Inflationary and Deflationary Trends 

Perhaps the second most emphasized effect for the economy as a whole is the 
accentuation of inflationary and deflationary trends. Apparently it tends to speed 
up expansion plans during good times, but deprives business of an opportunity to 
provide reserves for future expansion, or a cushion with which to maintain em- 
ployment and dividends during recessions. 

"Perhaps the real problem is in the area of future . . . needs. . . . Any statute 
. . . which tends to lessen the national cushion against unemployment and bank- 
ruptcy is ... to some degree a threat to our national economic situation and 
perhaps to our political system. There is considerable evidence that Section 102 
may be such a law." Mickey (98-99). 

"From the cyclical standpoint, in terms of accentuating booms and busts in the 
economy, I suppose that virtually all effects of 102, both the logical and illogical 
ones, would be bad, and I see nothing in the evidence . . . that refutes that." 
D. T. Smith (165). 

This effect was further commented upon by Gainsbrugh in the policy panel 
(i97» 229). 

3. Weakening of Enterprise Through Over distribution and Resultant 
Inability to Meet Capital Requirements 

The weakening of enterprise through overdistribution is related to the two pre- 
ceding effects. See also references relating to Forcing Dividends. 

As a result of the scarcity of equity capital, it was further pointed out that 
earnings were the major source of capital funds by Connolly (236), Gainsbrugh 
(224), and Sonderman (239-40). 

Slitor said that "it was believed by some that the relative scarcity of equity capi- 
tal is in part induced by the comparatively small flow of dividends, and that the 
apparent stringency of venture capital and equity capital would automatically be 
removed if dividends assumed the same relation to earnings that they did before 
the war" (232). 

4. Shift from Equity to Debt Financing 
The choice of debt rather than equity financing resulting from 102 was men- 
tioned by fifty- two questionnaire respondents. Four of these, however, reported also 
an opposite effect on the part of some of their clients, questionnaire (19-20). See 
also in this connection Turner (66), Cooper (76), and Dixon (126). 

5. Shift from Local to Foreign Enterprise 
This was referred to by Cann (47). 

6. Retardation of Business Growth 
Duiker (202). See also Results of Forcing Dividends. 

7. Impediment to Job Creation 
Gainsbrugh referred to the relation between the problems of funds for capital 
expansion and the problem of job creation (224). 

The counter arguments with respect to specific criticisms of Section 102 have 
)een indicated in connection with these criticisms. 

A. Necessary Part of Income Tax Law 
The basic justification of the provision is that it is a necessary part of the in- 
come tax law, in order to prevent dominant stockholders from avoiding payment 
of individual income taxes by influencing the corporation to retain profits rather 


than to distribute them in dividends. It is argued that the section thus (a) insures 
equity as between individual taxpayers — "When one group of taxpayers doesn't 
pay all the taxes it should all of the other taxpayers in the country have to pay 
more than they would" — Rudick (61), and Dixon (155); (b) prevents tax evasion 
through use of the corporate device — "If you don't have some mechanism which 
will prevent the use of a corporation as a refuge from surtax you will have so 
much avoidance that the effects will be far more serious than under the present 
system," Rudick (61, 155), Cooper (168), Mickey (154), Piatt (155); (c) protects the 
revenues, not so much through the amounts directly collected under Section 102, 
as through the prevention of individual surtax avoidance through corporate reten- 
tion of profits, George (154), Rudick (155), and D. T. Smith (167). "One of the 
greatest troubles with Section 102, so far as taxpayers are concerned, is that it 
accomplishes what it really is designed to accomplish. I think that the increase in 
the number of cries of anguish that are heard, as individual tax rates go up and 
as profits go up, is some testimony in that respect. Unless 102 is considered . . . 
as a part of . . . the income tax and as an aid to its enforcement and collection, 
we shall lose some perspective on the problem." Mickey (97). See also Duiker (200) 
and Richardson (210). 

B. Reasonable and Fair Interpretation of Law 
The generally reasonable and fair interpretation of the law was advanced in 
further defense of the provision: Sibley (53), Mickey (98, 99-100), Miller (144), 
Cann (151), questionnaire (13, 26), Duiker (203), Gainsbrugh (229), and George 

C. Causes Year-end Appraisal and Long-Term Program by Management 
Piatt advanced the further argument in defense of the section that the "careful, 
well-considered thought given to the corporation's year-end position and future 
needs, which is induced by Section 102, may perhaps be a good thing in the long 
run" (86). See also Rudick (114). Ayers questioned this point of view (114). 


Some participants pointed out that the section had no important over-all effect 
upon the economy — "may be terribly important to particular companies . . . but 
taking the economy at large I don't think it has any significant effect." Rudick 
(59). Piatt thought the percentage of corporations affected would be "very small" 

Dixon thought there was nothing to fear from 102 by most corporations and that 
the exceptions "are too small in percentage, too small in number, and the dollars 
involved don't amount to peanuts alongside of the general economy" (125, 155). 

The other participants largely conceded that point, but expressed the view that 
although the provision did not affect the majority of the corporations, it discrimi- 
nated unfairly against certain types of business enterprise, notably small business — 
particularly of the family type— light industries, debt-free industries, those engaged 
in jobbing distribution and service activities, and those with high turnover of 
inventories and receivables and enterprises with highly variable earnings; and that, 
moreover, many other nonvulnerable enterprises worried needlessly over the pro- 
vision. Austin (39-40). 

It was further pointed out that even though only 5 or 10 per cent of the 
corporations were unfairly affected, still that was too many for the good of the 
economy. "But even if we . . . admit that there are comparatively few cases in 
which 102 has really been effective . . . and affects, let's say five or even, at the 
most, ten per cent of our business organizations, I think that's bad." Cooper (74). 
"I think too that the 10 per cent would be the small corporate companies, not the 
large." Cooper (116). 


". . . the fact that one fellow is going to be O.K. doesn't do the fellow any good 
who is being hurt. * Ayers (83). 

". . . if it affects even a relatively small percentage of the closely held companies 
adversely ... it is a harmful situation to be faced with. I again go back to the 
assumption that our economic theory is one of maintaining the growth and devel- 
opment this country has had through private, individual management of its busi- 
ness affairs during the past half century." Ayers (116). 

Mr. Miller held that the present 102 compulsion is too great for future welfare 

The questionnaire respondents indicated that somewhat more than half of the 
corporations represented by them were very much concerned with the section. 
Questionnaire (11). 

The limited application of the section in court decisions was referred to by 
Richardson (210-11); Slitor (214). It was stated that the court cases are not a 
measure of the effect. Ayers (108). 

Connolly commented on the small amount of tax collected (218). 

It was pointed out that the amount of revenue collected was not as significant 
as the amount of distributions made as a result of tax, George (21*, 218) and 
Slitor (218). ' 

A few of the fact-finding panel participants considered that there had been too 
much emphasis on 102. Dixon in particular stressed this point. ". . . we need more 
education among our own tax practitioners on this whole subject, so that they 
won't be accelerating the nebulous fear of the businessman," he said (126). 

Other practitioners disagreed with this point of view. "I don't think ... we 
can dismiss that situation by saying that wrong advice is given to taxpayers and 
perhaps their counsel are too fearful of 102." Silverson (135). 

"I disagree with those who feel that ignorance accounts for the fears entertained 
by some executives. ..." Miller (143). 


A. Procedural Changes 
1 . Clarity 


There were repeated references in both panels to the suggestion that the Bureau 
publish sound reasons for retention: Cann (153), Cooper (77), Duiker (200, 209, 
260, 261), George (171), Gornick (208), Richardson (212-13), and Sonderman (241). 

Panel action (263-71). 


The possibility of an educational program on the part of the Treasury or by 
some organization or periodical was mentioned by Dixon (126) and Gainsbrugh 

Panel action (271). 


Panel action (271-72). 

2. Internal Review 
Discussed by Duiker, George, and Richardson (228). Advance rulings were sug- 
gested by Duiker (260). 
Panel action (272-74). 

3. Timing 
Several participants recommended that the taxpayer be allowed credit for divi- 


dends paid after the end of the year: Austin (256), Cooper (141), Dixon (125), S. A. 
Smith (176), and Sonderman (238). 
Panel action (274-75). 

B. Criteria for Legislative and Administrative Rules 
1. Limitation of Area of Challenge 


Arbitrary exemption of certain types of corporations by size or by degree of 
control was recommended by Ayers (157), Cann (153), Duiker (259-60), Gornick 
(206-7, 216), Miller (145-48, 175), Richardson (211-13), and Sonderman (240). 

This recommendation was questioned by Austin (215-17), Connolly (217-18), 
Dixon (149-50), and S. A. Smith (149). 

General discussion (149-51). Panel action (275-77). 


Recommended by Sibley (172); questioned by Austin (255-56). Panel action (277- 


Gornick (207). Panel action (280). 


Recommended by Cooper (157), Duiker (259-60), Gornick (216), Sibley (173). 
Panel action (280-82). 


Recommended by Sibley (173). Panel action (282-83). 


Recommended by Silverson (136-39), Connolly (219), and Gemmill (205); ques- 
tioned by Cooper and Rudick (137-39). Panel action (283-87). 

2. Evidence 


(1) Immediacy. The problems created by the immediacy doctrine of the Treas- 
ury were repeatedly emphasized by the participants of both panels. See I B 1 Im- 
mediacy Doctrine and Difficulties of Foreseeing Future. A number of participants 
recommended a broader interpretation of reasonable needs and permission for 
long-range planning: Austin (257), Dixon (125), Duiker (202), Gainsbrugh (205), 
George (171), and Sonderman (239). Panel action (287-89). 

(2) Longer Statute of Limitations. Panel action (289). 

(3) Averaging. Permission to average accumulations over a multiple-year period 
was advocated by Gainsbrugh (229), Gornick (207), and S. A. Smith (95). Panel 
action (290-92). 


Sibley proposed that the right of reinvestment should be inviolate if related to 
the business of the taxpayer (172). Panel action (292-93). 

C. Burden of Proof 

A number of panel participants favored shifting the burden of proof: Austin 
(255), Ayers (122), Cann (153), Connolly (219, 221), Dixon (125), Richardson (211- 
12, 219), S. A. Smith (95), Sonderman (237), and Turner (64). 

Gornick pointed out that the burden of proof element never entered into the 
picture in most cases because they never reached the point of litigation (206). 
Gemmill stated that he "never thought that the burden of proof standpoint really 
got very far in this whole field, because when it comes to a question of actual 
litigation the burden of proof usually falls by the wayside" (204). 


Duiker proposed that the burden of proof be divided by shifting it to the Com- 
missioner in cases where he felt retention was for the purpose of avoiding the sur- 
tax on shareholders, and leaving the burden on the taxpayer where retention ap- 
peared to be for business reasons (198-202). This proposal was discussed by various 
participants (203-6, 217, 219-21). Panel action on burden of proof (293-95). 

D. Deficiency Dividend Credit 
A deficiency dividend credit was discussed by Austin (256), Connolly (220), Gem- 
mill (220), and Sonderman (238-39). Panel action (295-300). 

E. Presumption of Reasonable Accumulation 
Panel action (300-1). 

F. Miscellaneous Proposals 

A countervailing levy was suggested by Vickrey and discussed by other panel 
participants (193-96, 243-55). 

Duiker suggested Bureau consideration of a company's record of expansion (200, 
260), and limitation to year currently under examination (200). 

Gornick and Duiker suggested that there be no question relating to payments 
of debts and obligations in any one year (261). 

Justification of retention of earnings in good faith was advocated by Austin (258) 
as a substitution for the immediacy concept. 

The exclusion of long-term capital gains (238) and credit for capital additions 
and depreciation (241) were recommended by Sonderman. 

Vickrey expressed the opinion that if an adequate assessment of capital gains 
were available there would be no need of 102 (194). 

Sonderman felt that the section should be treated as a penalty section and spar- 
ingly applied (240). See also discussion by Duiker, et al. (221). 

Repeal of Section 102 was advocated by Mickey (173) and Connolly (217, 219). 

On the other hand, Slitor pointed out that there are some persons who feel that 
the section should be made more stringent (232-37). 

Many participants expressed the opinion that in view of high individual surtaxes 
it was necessary to have 102 or some similar provision to prevent tax avoidance, 
but conceded that it could be improved. 

"We ought to keep the teeth in the law." Duiker (205). 

Cann advocated consideration of preceding and subsequent years (68). 

Permission for funding depreciation was recommended by Cann (47) and Dixon 
(130-31). See also footnote (47). 

Silverson recommended more centralized administration (136), and suggested that 
a special section of the Bureau in Washington approve a proposed deficiency be- 
fore the taxpayer is called upon to defend his position (177). 

Sibley suggested that the decision of the board be prima facie justification, and 
that approval of 75 per cent of the minority with 30 per cent of the stock be 
conclusive (172). 


Note: Mr. Slitor did not participate in the formulation of policy recom- 
mendations and did not vote on any proposals. Mr. Gemmill was not present 
when the voting took place, and Mr. Connolly had to leave before it was 
completed. Mr. George refrained from voting. 

1 See pages 190-92 for digest of proposals as submitted to policy discussion panel. 


A. Procedural Changes 
i . Clarity 


A majority of the panel felt that it is desirable and possible for the Commissioner 
to enlarge upon and clarify his present releases relating to conditions that justify 
retention without undue damage to the purposes of the act. The panel had in mind 
particularly recognition of reserves based on replacement costs; recognition of long- 
term expansion program; establishment of a unit in the Bureau to which the tax- 
payer could apply for rulings, which would be good unless voided by the Commis- 
sioner within seventy-five days; special consideration to concerns with a record of 
payments or expansion; special consideration for small business; and clear allow- 
ance of prepayment of debts or obligations. 


The panel considered that further clarification by the Commissioner, as indicated 
in preceding paragraph, would obviate the necessity for such a campaign, and that 
at present it was not a question of education, but of real uncertainty. 


The view was expressed that this was not a tax question but one of substantive 
law and would be dependent upon the law of each particular state, and that under 
the tax law the most that could be done would be to give some relief to the direc- 
tors by means of a provision for a deficiency dividend credit. 

2. Internal Review 
There was general agreement on the part of the panel that it would not be 
feasible to have a proposed 102 deficiency approved by a special section of the 
Bureau at Washington before the taxpayer is called upon to defend his position. 

3. Timing 
The panel held unanimously that it would be feasible and desirable to allow 
corporations to satisfy the requirements of Section 102 by additional dividends paid 
within two and a half months after the close of the fiscal year. 

B. Criteria for Legislative and Administrative Rules 
1. Limitation of Area of Challenge 


Some of the panel members thought it would be desirable to redraft Section 102 
so that it would require consideration and policing of only those corporations whose 
dividend distributions need to receive the attention of the government. Others con- 
sidered that such a limitation would not be politically feasible. 


The proposal that an accumulation of a specified percentage in any one year be 
exempt was rejected by a majority of the panel. 


The panel concluded that a percentage of accumulation exempt over a three- 
year priod was nonadministrable. 


The idea of allowing a flat exemption of $100,000 of earnings was rejected by 
the panel. 


The proposal that the penalty tax rates be reduced by half was not adopted by 
the panel. 



The panel was divided on this proposal. Some members thought this represented 
a desirable objective, but that it might provoke litigation. Other panel members 
considered it undesirable. 

Gornick and Richardson favored such a provision, Duiker and Austin opposed it, 
and Gainsbrugh, Sonderman, and Vickrey were uncertain. 

2. Evidence 


(1) Immediacy. The panel was unanimously in favor of allowing a business to 
accumulate against foreseeable needs in the distant future. 

(2) Longer Statute of Limitations. The panel rejected the proposal that a 
longer statute of limitations would be warranted as a means of extending the 
period within which use of accumulations could be shown. 

(3) Averaging. There was no unanimity on the subject of averaging accumula- 
tions over a multiple-year period. 


The panel considered that a provision, stating that the right to invest should be 
inviolable if the investment is related to the business, is unnecessary. 

C. Burden of Proof 

The panel favored eliminating the words "by the clear preponderance of evi- 
dence" with respect to burden of proof. 

The panel did not approve the proposal that the burden of proof be divided, 
but favored the proposal that the burden of proof be shifted to the Commissioner. 

D. Deficiency Dividend Credit 
The panel approved a proposal that a credit of 90 per cent be allowed against 
the amount of the deficiency if the taxpayer distributed the amount upon which 
the determined tax was based (less subsequent dividend distributions in excess of 
Section 102 net income) within ninety days of filing of notice. 

E. Presumption of Reasonable Accumulations 
After some discussion as to whether the law should be amended to create a pre- 
sumption that in the case of operating companies profit accumulations are reason- 
able unless the Treasury shall prove the contrary, the panel decided that it was 
not necessary to take action on this question since it was really covered by the 
shift of the burden of proof. 



Preliminary Statement 

Allan F. Ayers, Jr. 

Hodges, Reavis, Pantaleoni & Downey, New York 

The Tax Institute's consideration of Section 102 of the Internal 
Revenue Code is divided into three parts: a questionnaire survey; 
a panel discussion to develop the facts with respect to the economic 
effects of Section 102; and a panel discussion of policy with respect 
to the section. Understanding of the problems requires at least a 
general orientation of Section 102 in the broad field of federal income 

What the Section Is 

Section 102, as it now exists, imposes a surtax ranging from 271/2 
per cent to 381/2 per cent on the net income of a corporation which 
accumulates its current earnings for the purpose of avoiding individ- 
ual surtaxes on its shareholders. 

Accumulations in prior years are not subject to tax, although they 
will have a bearing on determining whether or not current accumula- 
tions are reasonable. 

The law provides that the fact that any corporation is a mere hold- 
ing or investment company shall be prima facie evidence of a purpose 
to avoid surtax upon shareholders and it also provides that the fact 
that earnings or profits of a corporation are permitted to accumulate 
beyond the reasonable needs of the business shall be determinative of 
a purpose to avoid surtax upon shareholders unless the corporation 
proves the contrary by a clear preponderance of the evidence. 

The tax is imposed upon the entire undistributed net income of 
the corporation with certain adjustments specified in the statute and 
no credit is allowed for amounts reasonably accumulated during the 
taxable year. Thus, if a corporation has net income, after dividends, 
of $100,000, reasonably accumulates $30,000, and is found to have 
accumulated the remaining $70,000 in order to avoid surtax upon its 



shareholders, the Section 102 tax will be imposed on the entire 
$100,000 of undistributed net income instead of on the $70,000 un- 
reasonably accumulated. 

History of the Section 

Section 102, or a provision analogous to it, has been in the federal 
income tax laws ever since the Act of 1913, which was enacted after 
the adoption of the Sixteenth Amendment to the Federal Constitu- 
tion. Prior to the Revenue Act of 1921 (except for the year 1917) the 
tax was imposed upon the shareholders of corporations availed of to 
avoid imposition of surtax upon the shareholders. In 1917 and since 
1921 the various applicable statutes have imposed the tax directly on 
the corporation. 

The form of the statute has been changed from time to time. The 
first change imposing the tax on the corporation instead of on the 
shareholders was made to meet doubts as to the constitutionality of 
the original tax imposed on shareholders. Since 1921 changes have 
been made for administrative reasons and also to strengthen the 
provisions of the law and to impose a greater burden of proof upon 
the corporate taxpayer in defending itself against a surtax asserted 
under this section. 

Section 102 has always been somewhat of a bugaboo to tax advisers 
to closely held corporations, but it can hardly be said to have achieved 
a real prominence until after the famous question 8 was inserted in 
the corporate income tax return for 1946. 

Question Relating to 70 Per Cent Distribution 
During the war years, the government is said to have declared a 
truce on enforcement of Section 102 although some cases involving 
Section 102 during those years have reached the courts. The excess 
profits tax was terminated in 1945 and question 8 then appeared on 
the corporate income tax return for the year 1946. This question, in 
effect, required corporate taxpayers to explain the reasons for not 
distributing more than 70 per cent of their current net income. 

Various guesses were made as to the reason for the appearance of 
question 8 on the return. It does not seem unlikely that the Treasury 
thought the presence of the question would result in a more liberal 
dividend policy by corporations which might be vulnerable to attack 
under Section 102. Such a motive was, at least, inferentially denied 
by the Treasury. In various releases and statements of policy by 
Treasury officials, it was said that the question was put in the return 


for the convenience of taxpayers. It was also stated that the Treasury's 
policy was not to interfere with the normal function of management 
in guiding corporation operations, and that its enforcement policy 
would be no more stringent than in earlier years. 

The appearance of question 8 on the return resulted in a flood of 
literature on the subject and considerable "viewing with alarm." 

It is interesting to note that the question was deleted from the 1947 
and subsequent corporate income tax returns. 

The figure of 70 per cent in question 8 is traceable to a Treasury 
Decision in 1939 (T.D. 4914, CB 1939-2 p. 108) which called specific 
attention to the possibility of asserting a Section 102 surtax if at least 
70 per cent of net income was not distributed in dividends. The figure 
was not an absolute; less than 70 per cent distribution would not 
necessarily make a particular taxpayer vulnerable and more than 70 
per cent distribution might not protect another taxpayer. The 70 per 
cent figure was supposed to represent a normal distribution of corpo- 
rate income. Based on current practices that would probably be a 
high figure. 

Importance of Section 

From the standpoint of either volume of litigation or volume of 
revenue collected under it, Section 102 is relatively unimportant. Very 
few cases were decided on the subject prior to 1932 and altogether 
there are only about one hundred court decisions involving the ap- 
plication of Section 102. 

Figures obtained from the Bureau of Internal Revenue and sub- 
mitted to the fact-finding panel indicate that up to June 30, 1949, 
approximately 1,296 cases (exclusive of litigated cases) which involved 
Section 102, or similar provisions of prior laws were handled by the 
Bureau of which 156 were still open. The figure given does not in- 
clude cases settled after July, 1939, for tax years prior to 1938, as to 
which no figures are available. "Case" as used by the Bureau means 
case years so that the number of taxpayers actually involved probably 
is substantially lower, since the same taxpayer might be involved for 
two or more years. 1 

One of the purposes of the panel discussion reported herewith was 
to ascertain whether Section 102 was a matter of greater importance 
to the business community than the volume of litigation or revenue 
collected under the section indicated. 

It seems to be generally accepted that Section 102 is not a matter 

1 See Table on page 93. 


of concern to a corporation whose stock is widely distributed. It is a 
matter of concern to closely held corporations whose shareholders are 
in the higher income tax brackets, and also to corporations a sub- 
stantial part of whose stock is controlled by a relatively small group, 
notwithstanding that the balance of the stock might be widely dis- 

The participants in the panel represented a diversified group of 
industrialists, accountants, and attorneys. Some of the participants in 
the panel felt very strongly that Section 102 had a bad economic effect. 
Others felt that the psychological effect of the statute was overem- 
phasized and that the section was not of great economic significance. 
Other opinions fell, at various points on the spectrum, between the 
two extremes. The reader will have to draw his own conclusions based 
on his own experience and his evaluation of the facts brought out 
by the panel. 

I should not close this statement without expressing my thanks to 
the Tax Institute for the privilege and opportunity of participating 
in this interesting study. My colleagues on the fact-finding panel de- 
serve high praise for their stimulating discussion and their objective 
consideration of the problem at hand. 


Questionnaire Survey 

As a part of its investigation of the economic effects of Section 102, 
the Tax Institute sent the following questionnaire to approximately 
1,700 tax practitioners, consisting of the practitioner members of the 
Tax Institute, registrants at the New York University Institute on 
Federal Taxation, and a New York University practitioner discussion 

October 13, 1949 


1. If your corporate tax clients increased dividend distributions after 1945, please 
give an estimate of the percentage of these clients where the fear of 102 was a 

(a) Sole controlling factor % (d) An incidental factor % 

(b) Major controlling factor % (e) An inconsequential factor % 

(c) A contributing factor % (f) Not considered % 

2. If your corporate clients increased dividends because of fear of 102, please in- 
dicate the financial effects or business decisions resulting from such increases. 


Frequently Infrequently 

(a) None 

(b) Conversion of assets 

(c) Increased borrowings: 

From stockholders 

From banks or other outside sources 

(d) Curtailment of operations 

(e) Additional stock issues 

(f) Others. List briefly and check 

3. Exclusive of dividend policies, were other actions of your corporate tax clients 
either stimulated or retarded in some way by 102? Please indicate which. 


Frequently Infrequently Frequently Infrequently 

(a) Expansion or rehabilitation of 
plant, or acquisition of new 


(b) Development of a wholly new 

product, never produced before 

(c) Improvement, extension, or em- 
bellishment of a previous product 

(d) Acquisition of properties 

(e) Mergers or sales of businesses 




Frequently Infrequently Frequently Infrequently 

(f) Change from corporate to part- 
nership or sole proprietorship 

form _ _ 

(g) Complete liquidation and discon- 
tinuance of business in any form 

(h) Choice of debt financing rather 

than equity financing 

(i) Resort to outside sources for 

financing by borrowing or issues 

of new stock _ 

(j) Pension and profit sharing plans 

(k) Reduction of debt 

(1) Increase of inventories _ " 

(m) Other actions. State briefly "" " 

Check in each group below the class of corporation where management decisions 
by your tax clients have been influenced in any way by 102. 
(a) Kind of business 10 to 25 

Personal service corporation . 25 to 100 ]_U __™ 

Textiles Over 100 "" 


Publishing ( c ) Net Assets 

0thers: Less than $20,000 

$ 20,000 to $ 50,000 

$ 50,000 to $100,000 

(b) Number of stockholders $100,000 to $250,000 

Less than 5 $250,000 to $500,000 _ 

5 to 10 Over $500,000 

5. Has Section 102 by forcing dividends on the part of any of your corporate 
clients retarded their venturing of capital investments in 

Check Here and 

Indicate Number of 

Clients Affected 

(a) A wholly new product — completely novel — never produced before 

(b) An improvement — extension — embellishment of a previous product 

6. Check your estimate of the average annual number of corporate clients your 
office has represented in tax matters over the last four years. 

(a) Under 50 50-100 100-200 over 200 

(b) If you have been engaged exclusively by one corporation for the last four years, 
check here 

7. What is your estimate of the percentage of your corporate tax clients where 
the 102 problem was considered by you or your client? 

(a) Casually % (c) Intensively % 

(b) Carefully % 

The questionnaire was accompanied by the following letter from the 
president of the Tax Institute. 


I'd like you to do me a personal favor. 

The Tax Institute is conducting an extensive research job on the impact of taxes 
upon productive investment. You'll find it described on the enclosed leaflet. 

We need actual, down-to-earth, authentic information on the effect on business of 
Section 102. I can think of no better source than the practitioner members of the 
Tax Institute, the participants of our New York University Institute on Federal 
Taxation, and an N.Y.U. practitioner discussion group. You have had actual ex- 


perience with the Section. We can get a good picture of the ramifications of 102 
if you will spend a few minutes with the enclosed questionnaire. 

We have had voluminous writing on 102. What is now sought is some concrete, 
practical evidence from professionals who handle the problem in their daily activi- 

May I invite you to answer this questionnaire. I personally assure you there will 
be no tie-in of your information with yourself. You don't have to identify yourself 
at all. We're enclosing a self-addressed stamped envelope. Please let us have your 
reply by October 31, if possible. 

Many thanks. We'll be glad to send you the results of this research. 

Very truly yours, 

(signed) J. K. Lasser 

P.S. You might be interested in giving us suggestions, criticisms, reactions, or any- 
thing else on Section 102 and the economic effects it produces. We'd be glad to re- 
ceive them on a separate sheet, anonymous or otherwise. 

The questionnaire had been prepared by the following committee 
appointed for the purpose by the Tax Institute Panel Committee: 
Alfred G. Buehler, Chairman; Maurice Austin, J. K. Lasser, Sydney 
Prerau, Weston Vernon, Jr., and K. M. Williamson. Early drafts of the 
questionnaire were submitted to various persons for criticisms and 
suggestions. After considerable revision, the questionnaire as presented 
above was approved for mailing. 

Results of Questionnaire 

One hundred and ninety responses have been received to the ques- 
tionnaire survey. One hundred and fifty-three respondents returned 
filled-in questionnaires. Thirty-seven sent letters of brief comments. A 
few respondents indicated they were not in practice and hence had 
no information to contribute. 

The replies were received from all sections of the country as indi- 
cated below. 

Section Number of Replies 

New England States 11 

Middle Atlantic States 54 

East North Central States 27 

West North Central States 13 

South Atlantic States 20 

East South Central States 10 

West South Central States 8 

Mountain States ■. 2 

Pacific States 5 

Hawaii 1 

Unidentified 2 



The discussion in the fact-finding panel serves to amplify and 
clarify the questionnaire results. Through the questionnaire, concise 
replies were received from 190 respondents. Through the panel, there 
was obtained fruitful and intensive discussion of the experiences of 
practitioners and businessmen. The two investigative techniques ad- 
mirably complement each other. 

The questionnaire information may be summarized under three 


I. What proportion of the corporations of the country are affected 

by Section 102? 
II. What type of corporations are affected? 
III. How are the corporations affected? 

I. What Proportion of Corporations Are Affected? 

Preliminary interviews prior to mailing the questionnaire had indi- 
cated that the impact of Section 102 was by no means universal. For 
example, it was generally recognized by persons familiar with the 
subject that large publicly held companies did not consider them- 
selves likely to be affected by the provision. Even among small, closely 
held companies, a number of factors would affect the impact of the 
tax. But so far as could be discovered, no estimates or even guesses 
were available as to the proportion of corporations that might be 

Before trying to find out what types of corporations are affected and 
what the effects are, it seems desirable to gain some indication, how- 
ever crude, of the proportion of companies affected. Certainly the 
results of this questionnaire can serve only to give a very rough 
approximation of this number. 

Approximately 1,700 questionnaires were mailed out. Because of 
the method of selecting the recipients, it is believed that these prac- 
titioners represent a substantial sample of corporations able to rely 
on professional tax assistance, either through their own tax depart- 
ments, or through the patronage of high grade legal and accounting 
firms. Responses were received from more than 10 per cent of those 
circularized. From the replies to question 6 it is estimated that those 
who responded represented approximately ten thousand corporations. 
In arriving at this figure the second category may have been overesti- 
mated, but if so it has been more than compensated by computing the 
other figures at the lowest figure in the bracket. 

Exact statistical results concerning the number of corporations af- 
fected cannot be obtained from the questionnaire survey, because most 


of the information was obtained from practitioners who were asked 
only to indicate the approximate rather than the exact number of 
their clients. Nevertheless, the results do yield some general indica- 
tions concerning the number of corporations affected. 

Number of 

Number of 



Number of 





by Each 

Clients per 

Number of 






2 - 50 




50 - 100 





100 - 200 
Over 200 





* Plus 3 who gave no data on number of clients and 37 persons replying only with brief 

It is estimated that the 153 practitioners returning questionnaires 
represented approximately 10,000 corporations. The questionnaire re- 
plies indicate that approximately 19 per cent of these corporations 
give no consideration whatever to Section 102; 25 per cent give it 
casual consideration; 34 per cent consider it carefully; and 22 per cent 
give it intensive consideration. 

In other words, slightly less than half of the corporations repre- 
sented (apparently in the main large publicly held, very small, small- 
profit, and debt-ridden corporations) are little concerned with the 
section. Somewhat more than half of the corporations are very much 
concerned with the section. Apparently these corporations are the 
profit-making small and medium-sized corporations and the large 
corporations that are closely held. 

It appears that the impact of the provision is greater upon some 
lines of enterprise than on others, and also, due to variations in 
enforcement, in some sections of the country than in others. 

One Oregon practitioner with 50-100 clients stated: "Section 102 is 
at least considered on every corporate job, unless it is clearly evident 
that Section 102 does not apply." An Ohio practitioner with 100-200 
corporate clients said: "They often don't think about it ahead of 
time." A Pennsylvania practitioner who gave no figures concerning 
the number of clients said that 5 to 10 per cent considered it seriously, 
and that others considered it, but deemed they were not particularly 


Another accountant stated: 

As the number of my corporate clients is small (about 35) and most of them are 
small corporations, I have not answered the questionnaire. Owing to my five years 
experience as a Revenue Agent (1935 to 1940) I always have Section 102 in mind 
in advising clients about dividends and the more or less related subject — salaries 
of officers. I can not say just how many have been controlled by Sec. 102, but cer- 
tainly fear of this section has had an influence with all closely held corporate 
clients that have had profits. Also, in a couple of cases, this Section has prompted 
more building improvements than would have been done otherwise. 

I have never had Sec. 102 invoked on a client, although the question has been 
brought up occasionally by a Revenue Agent. Also, in my five years as a Revenue 
Agent I never invoked it, but did discuss it. 

Personally, I think it is exaggerated in its importance, but the possibility of it is an 
influence that must constantly be in the minds of an accountant, and the fear of it 
is a factor in business management that is sometimes detrimental to proper opera- 

Some other practitioners also indicated that they thought the effect 
of the section was exaggerated. A tax practitioner in South Carolina 
whose clients were small corporations with stockholders frequently 
active in the business said: "We have never regarded this problem to 
be as serious as the tax publications and some practitioners viewed it, 
and our opinion has always been that any corporations which could 
show a need for their surplus, would not be disturbed." 

A practitioner in Tennessee said: "Personally, I feel that 102 has 
a very limited effect in this section except some nuisance value," and 
one in New York stated: "I do not believe that Section 102 need in- 
terfere in any way with normal operations, nor does it present any 
real danger in such cases, although it does sometimes result in incon- 

On the other hand, a practitioner from Kentucky said the "prob- 
lem's really just beginning to be acute in the medium and small corpo- 
rations. Most of them in the past have felt that 102 was something 
that happened to U. S. Steel." 

II. What Types of Corporations Are Affected? 
The questionnaire asked three questions designed to obtain infor- 
mation concerning the types of corporations affected. These related to 
the nature of the business, the number of stockholders, and the net 
assets of the corporation. It is unfortunate that only a few kinds of 
business (personal service, textiles, glass, and publishing) were spe- 
cifically enumerated in the questionnaire, since apparently business 
enterprises of almost all kinds have been affected. 

Kind of Business 

One hundred and thirty-two respondents answered this question. 


Several respondents wrote in the types of other clients affected. The 
leading kinds of business enumerated were as follows: 
Textile companies listed by 37 practitioners 

Personal service 

" 30 




Glass " 

" 24 
' 17 
' 12 

' 7 

Auto dealers 

" 7 

Paper products 
Lumber " 

' 7 
' 6 

Steel and iron 

' 5 

The following additional types of business were mentioned by one to 
four practitioners: security dealers, finance, oil, minerals, chemicals, 
food processing, autos, furniture. Sixty-nine respondents merely indi- 
cated "Others" in response to this question and did not specify the 
kind of business. It must be remembered that these figures relate to 
the number of practitioners, but give no indication of how many of 
their clients fall in each category. 

One respondent from Ohio replied that machine shops and retail 
automobile sales agencies were "presently under the gun," and that 
both had been long-profit operations and were in the main closely 
held. Assessments have been considered but not made against the 
machine shops which secure the major part of their business from 
the rubber and automobile industries. The Department has accepted 
their defense based on strikes, material shortages, and segregation of 
industries and no tax assessments have been made. The retail auto 
dealers have been "pressed in a number of instances." Their defense 
has been that they are planning to purchase their own buildings (most 
of them rent); that they hope to get in the position of covering their 
own accounts, rather than having their sales financed by a financing 
agent; and that they should be financially able to operate their busi- 
ness the same way as other business. The respondent added that he 
was told by a member of the Department that they were in no position 
to dictate to a taxpayer how he was to run his business, as one tax- 
payer was entitled to the same business privilege as another. 

Apparently certain lines of business appear to be unaffected by the 
section. Respondent practitioners representing insurance companies, 
railroads, trust companies, and trade groups indicated that such clients 
were in general not affected, although one official of an insurance 
company stated: 

It is quite likely that the application of Section 102 curtailed the activities of cer- 
tain corporations in the purchase of business or key-man insurance. If your ques- 


tionnaire brings forth any comments as to the effect of Section 102 on the pur- 
chase of insurance, I would be very glad to receive the benefit of your experience. 
As a matter of interest, I would also be very glad to receive the results of your 
research for future reference. 

Another life insurance company representative also expressed keen 
interest in the findings. 

Number of Stockholders 

One hundred and forty-one respondents replied to the question 
relating to the number of stockholders in affected corporations. The 
information given with respect to their corporate clients affected by 
the section was as follows: 

89 practitioners mentioned clients with less than 5 stockholders 
71 » " " " 5-10 

49 » » " " 10-25 

37 " » " " 25-100 

43 » » " " over 100 

Again an unfortunate limitation in the questionnaire became ap- 
parent. Publicly held corporations normally have far in excess of 100 
stockholders and one or two further classes above 100 should have 
been included. Nevertheless, the data given do indicate that the over- 
whelming preponderance of the effect of the section is on corpora- 
tions with less than twenty-five stockholders. It is interesting to note, 
however, that 30 per cent of the practitioners reported that they had 
corporate clients with more than 100 stockholders that were affected. 
In this connection, see fact-finding panel discussion on pages 35-37. 

Net Assets 

One hundred and twenty-eight respondents gave information as 
follows with respect to the net assets of corporate clients affected 
by 102: 

9 practitioners 

mentioned clients with 

less than $20,000 net assets 


tt » » 

$ 20,000 - $ 50,000 " " 


>> » » 

$ 50,000 - $100,000 " " 


tt tt it 

$100,000 - $250,000 " " 


» » it 

$250,000 - $500,000 " " 


it tt tt 

more than $500,000 " " 

Since the respondents were not asked in connection with any of 
these three questions to indicate the number of affected corporations 
in each category, and since, moreover, many practitioners had diversi- 
fied clients and therefore checked one or more categories in each of 
these questions relating to the type of corporation affected, it is not 
possible to arrive at any numerical estimate of the number of corpora- 


tions in each category. The experience of the practitioners does indi- 
cate in a general way the types of corporations affected. If corporations 
with assets over $500,000 had been subdivided into more categories, the 
results would be somewhat more revealing. 

Tax executives of several large corporations reported that the Sec- 
tion was not of active concern. One company had 25,000 stockholders, 
another had 14,000 stockholders, and another 5,000 stockholders. In 
the case of the latter it was stated that "no officer, director, or stock- 
holder owns as much as 2 per cent of the stock and it has been the 
policy of the company to pay over 50 per cent of income in the form 
of dividends." Similar statements were made by other respondents 
representing publicly held companies. 

The tax executive of a large parent company with many subsidiaries 
stated that in one or two isolated cases Section 102 had prompted them 
to have the subsidiary pay a dividend to the parent corporation, the 
only stockholder. The action of the parent company had not been 
influenced in any respect by Section 102. 

Obviously the financial position of the company is of prime im- 
portance in considering its vulnerability. Companies that are not 
making profits and companies that have incurred substantial debt are 
in general not affected by the provision. Some replies indicated that 
companies with no large individual stockholders subject to surtax 
were also not vulnerable. 

One practitioner in Pennsylvania commented that the "return of 
the 'buyers market' and more normal conditions, in a competitive 
sense, are operating to make Section 102 a dead or dormant issue in 
this office." 

What Are the Economic Effects of Section 102? 
Increase in Dividend Distributions 

One hundred and forty-six indicated that consideration was given 
to Section 102 in making distributions by at least a portion of their 
clients. Two respondents claimed that none of their clients whose 
stock was widely held considered 102, but one of them stated that, of 
the closely held companies, Section 102 was a major controlling factor 
in 50 per cent of the companies, and a contributing factor in the other 
50 per cent. Two others, representing publicly held corporations, 
claimed that it was an inconsequential factor for all of their clients. 

Ten respondents, representing approximately 400 corporations, in- 
dicated that the section was the sole controlling factor in increased 
dividend distributions on the part of all their clients since 1945. 


Four respondents stated that it was not a sole controlling factor for 
any of their correspondents. The average practitioner considered that 
it was a sole controlling factor for 19 per cent of his clients. 

Eight respondents claimed that it was a major controlling factor on 
the part of all their clients. Three stated that it was not a major con- 
trolling factor in increased dividend distributions for any of their 
clients. Others specified that it was a major controlling factor for 
2 per cent to 90 per cent, with the average respondent considering it 
a major controlling factor for 22 per cent of his clients who increased 

Seven respondents considered the section a contributing factor in 
increased dividend distributions for all their clients, whereas three 
claimed that it was not a contributing factor for any of their clients. 
Others indicated that it was a contributing factor for less than 1 per 
cent to 90 per cent of their clients, and the average respondent claimed 
that it was a contributing factor for 18 per cent of his clients. 

One respondent considered the section an incidental factor for all 
his clients. Others claimed that it was an incidental factor for from 
none to 70 per cent of their clients, with the average practitioner 
considering it an incidental factor for 7 per cent of his clients. 

Two respondents stated that the section was an inconsequential 
factor for all of their clients, and others claimed that it was inconse- 
quential for none to 95 per cent. The average practitioner considered 
it inconsequential for 8 per cent. 

The average practitioner thought 9 per cent of his clients did not 
consider Section 102 at all in increasing dividend distributions. 

Difficulties involved in answering this question were pointed out 
by several respondents. One stated that he had insufficient data on 
which to answer the question, but that Section 102 was a major con- 
trolling factor in increased dividend distributions on the part of all 
the clients who consulted him about it. 

Judging by the answers received it appears that the average prac- 
titioner considered that Section 102 was a sole controlling factor in 
increased dividend distributions for roughly 19 per cent of his clients, 
a major controlling factor for 22 per cent, and a contributing factor 
for 18 per cent; that it was not considered by 9 per cent of his clients, 
and was incidental or inconsequential in the case of the others. 

The preceding figures serve only as an exceedingly rough indication 
of the probable effect of the provision in the minds of the practition- 
ers. A statistically precise measure of the effect of the provision is 
obviously impossible of achievement. 


Another stated: 

Helping the officers of our corporation clients to decide on dividend policy is 
one of our regular year-end jobs. We seldom make permanent records of the facts 
or the motives on which the decisions are based. For that reason the answers to 
the questions are largely the result of personal recollections of the staff members. 

The effect of the discrepancy between the high surtax rates and the 

Section 102 penalty was pointed out by some practitioners. One said: 

I have found that in my practice Section 102 has lost some of its effectiveness 
because the penalty rates have not kept pace with the very large increases in indi- 
vidual surtax rates. The result is, in many cases that have come to my attention, 
that the stockholder may be better off to allow the corporation to assume the risk 
of penalty under Section 102 and, if necessary, pay such penalty as against the 
immediate confiscation of any dividends considered through the effect of current 
individual surtax rates. 

Another stated: 

I might add, with reference to my own experience, that a great number of our 
corporate clients have given serious consideration to Section 102 because the stock- 
holders are so few, or in some instances, the stock ownership is heavily concen- 
trated in a few people. In such cases, we have advised them to build up a record, 
chiefly in their minutes, as to the reason for the retention of profits. In one case, 
in which one man owned all the stock, he preferred to gamble on the corporation 
paying out 27^ per cent rather than pay a substantially higher tax himself upon 
a dividend. 

One respondent stated that his clients did not increase dividends, 
but took other safeguards. In another part of the questionnaire, he 
indicated that the steps taken were expansion, acquisition of prop- 
erty, and change of form, and avoidance of substantial cash on hand 
or on deposit. 

One practitioner summarized his experience (which is being re- 
produced as probably fairly typical) as follows: 

The cases which I deal with fall into two distinct types. The first type is a large 
corporation with wide stock distribution, the stock of which is listed, and where 
no member of the board of directors has any personal interest in keeping down 
dividend distributions because of the tax effect on himeslf or on the persons he 
represents. In most situations of this type the problem is not serious and is given 
only casual attention. However, I find that directors, particularly in view of the 
Trico situation, are in some cases quite concerned to make sure that a substantial 
portion of the earnings is distributed as dividends so as to avoid any possible 
risk of personal liability. There is often something of a difference of opinion be- 
tween those directors whose main objective is to maintain an established dividend 
rate, if that can be done without unduly impairing the corporation's financial 
position, and those who, particularly in abnormally good years, wish to declare 
extras because of the Section 102 situation, rather than because of any feeling that 
the company has more funds and resources than it can usefully employ in the 

The second type of clients are the small, closely held, family or one-man cor- 
porations where the problem is often serious and is given much consideration. 
There is no doubt that many corporations have declared dividends because of Sec- 
tion 102 which they would not otherwise have declared. However, if the case is 


on the borderline and there are no outside investments or loans to stockholders or 
particular bad features of that type, there is a tendency in many such cases to 
take the risk of Section 102 rather than to distribute dividends and pay the high 
resulting personal taxes, on the theory that there is a fair chance of avoiding Sec- 
tion 102 liability and that even if it is incurred the result is not too bad as com- 
pared with the individual taxes which otherwise have to be paid. The fact that 
personal taxes may run up to over 70% and that the Section 102 penalty does not 
exceed 38^%, obviously has a bearing. 

An officer of a large corporation stated that in his opinion Section 
102 was more of a threat than an actual danger, but he pointed out 
that "we do not court the danger of additional tax when surplus war- 
rants. We recommend a dividend and at times a substantial one." He 
also added, "I am mindful of the Trico case which was very drastic 
and given wide publicity." 

Financial Effects Resulting from Increased Distributions Brought 
About by 102 

Three respondents said there had been no financial effects resulting 
from such increases. Another said "None yet," and another "Usually 
none." Seventy-four indicated there were frequently none, and one 
added, "Cash simply decreased." Twelve said that infrequently there 
were no financial effects. 

Thirty-six of the respondents who indicated that frequently there 
were no effects did point out other effects, however, and some indi- 
cated that they were frequent. 

Frequent Infrequent 

Conversion of assets 15 32 

Increased borrowing: 

From stockholders 10 22 

From banks or other outside sources 13 33 

Curtailment of operations 11 24 

Additional stock issues 7 23 

One respondent mentioned "Increase in officers' salaries" as another 
effect. Another respondent mentioned "Reorganization." A third 
stated that the increased dividends "in closely held corporations led 
to decision to dispose of stock." 

One hundred and thirty- three of the 153 respondents filling ques- 
tionnaires indicated effects exclusive of dividend policies. Nine indi- 
cated that there were no effects. Ten failed to answer the question. 
One replied, "Our experience too indefinite for opinions." 
The six most common effects in the order named were: 
Expansion or rehabilitation of plant, or acquisition of new machinery 106 

Acquisition of properties 93 

Reduction of debt 67 



Increase of inventories 

Change from corporate to partnership or sole proprietorship form 
Preference for debt rather than equity financing 



Effects Exclusive of Dividend Policies 


Fre- Infre- 
quently quently 


Fre- Infre- 
quently quently 

of Practi- 

(a) Expansion or rehabilita- 
tion of plant, or acquisi- 
tion of new machinery . . 62 

(b) Development of a wholly 
new product, never pro- 
duced before 5 

(c) Improvement, extension, 
or embellishment of a 
previous product 6 

(d) Acquisition of properties 42 

(e) Mergers or sales of busi- 
nesses 10 

(f) Change from corporate to 
partnership or sole pro- 
prietorship form 28 

(g) Complete liquidation and 
discontinuance of business 

in any form 4 

(h) Choice of debt financing 
rather than equity financ- 
ing 23 

(i) Resort to outside sources 
for financing by borrow- 
ing or issues of new stock 10 
(j) Pension and profit shar- 
ing plans 24 

(k) Reduction of debt 27 

(1) Increase of inventories . . 30 
(m) Other actions. State 

briefly — 





























A surprising feature of the replies was the number of practitioners 
who found that Section 102 was having diverse effects on different 
clients as indicated in the table on page 20. 

Comments on other effects were as follows: "No effect whatever;" 
"Reserves;" "Labor furloughed and research;" "Chronic desuetude;" 
"High individual tax rates have retarded payment of dividends; Sec- 
tion 102 has thus resulted in considerable expansion which might not 
otherwise have been undertaken; perhaps too much in some lines of 
business;" "Encouraged expansion;" "Bonus and salary increases;" 



Diverse Effects on Different Clients 


Frequency and Type of Effect 

Number of 











Expansion or re- 
habilitation of 
plant or acquisi- 
tion of new 


Development of a 
wholly new prod- 
uct, never pro- 
duced before .... 
Improvement, ex- 
tension, or em- 
bellishment of a 
previous product. 
Acquisition of 

Mergers or sales 
of businesses .... 
Change from cor- 
porate to partner- 
ship or sole pro- 
prietorship form. 
Complete liquida- 
tion and discon- 
tinuance of busi- 
ness in any form. 
Choice of debt 
financing rather 
than equity fi- 

Resort to outside 
sources for financ- 
ing by borrowing 
or issues of new 


Pension and prof- 
it sharing plans. . 

Frequently Stimulated & Infrequently Retarded 7 

Infrequently Stimulated & Frequently Retarded 3 

Infrequently Stimulated & Infrequently Retarded 1 

Frequently Stimulated & Infrequently Retarded 1 

Infrequently Stimulated & Infrequently Retarded 3 

Infrequently Stimulated & Infrequently Retarded 1 

Infrequently Stimulated & Infrequently Retarded 5 

Frequently Stimulated & Infrequently Retarded 2 

Infrequently Stimulated & Frequently Retarded 1 

Infrequently Stimulated & Infrequently Retarded 4 

Infrequently Stimulated & Infrequently Retarded 3 

Infrequently Stimulated & Infrequently Retarded 3 

Frequently Stimulated & Infrequently Stimulated 1 

Infrequently Stimulated & Infrequently Retarded 3 

Frequently Stimulated & Infrequently Retarded 1 

Infrequently Stimulated & Infrequently Retarded 3 

Infrequently Stimulated & Infrequently Retarded 4 

Frequently Stimulated & Infrequently Retarded 
Infrequently Stimulated & Frequently Retarded 
Infrequently Stimulated & Infrequently Retarded 
(k) Reduction of debt Frequently Stimulated & Frequently Retarded 

Frequently Stimulated & Infrequently Retarded 
Infrequently Stimulated & Infrequently Retarded 
Infrequently Stimulated & Frequently Retarded 
Frequently Stimulated & Frequently Retarded 
Infrequently Stimulated & Infrequently Retarded 
Infrequently Stimulated & Frequently Retarded 
Frequently Stimulated & Infrequently Retarded 

(1) Increase of inven 


"Bonus;" "Reduction of investments of current earnings;" "Avoided 
having cash on hand or on deposit of any sizable amount;" "Upon our 
advice none of clients have curtailed debt reduction or reduced any 
other prudent application of funds because of fear of 102;" "A rather 
apathetic attitude towards increased costs. Not to produce a new 

Fifty-eight respondents replied negatively to question 5a, "Has Sec- 
tion 102 by forcing dividends on the part of any of your corporate 
clients retarded their venturing of capital investments in a wholly 
new product — completely novel — never produced before?" One stated 
that the question was not applicable as his clients were in merchan- 
dising. Twenty-two stated that their clients (approximately a hundred 
clients affected altogether) had been retarded in venturing their capi- 
tal investments in a new product. 

Fifty-one replied negatively to question 5b, "Has Section 102 by 
forcing dividends on the part of any of your corporate clients re- 
tarded their venturing of capital investments in an improvement — 
extension — embellishment of a previous product?" Twenty- three re- 
spondents claimed that clients (totalling more than a hundred) had 
been retarded. 

An anonymous California respondent, who gave no indication 
whether he had any clients or not, stated that the section had no 
"effect whatever" and that question 5 relating to retardation of capi- 
tal investment was "Absolutely Ridiculous!" 

Comments on the Relation of Section 102 to Concentration 

of Industry 

Thirty-eight respondents indicated that 102 had stimulated mergers 
on the part of their clients. Ten reported that this had happened fre- 
quently and twenty-three that it was infrequent. Eight practitioners 
noted that it infrequently retarded mergers. Three of the eight were 
among those who also reported an infrequent stimulus to mergers. 

Thirty-one respondents reported that the section had brought about 
cases of complete liquidation and discontinuance of the business. Four 
of these stated that this result was frequent and twenty-seven that it 
was infrequent. On the other hand, seven respondents reported that 
liquidation had been retarded — one said frequently and six said in- 
frequently. Three of the latter said that the section had also infre- 
quently stimulated liquidations. 

The following comment on this trend was received from a tax law- 
yer in Washington: 


In my practice we had experienced a number of liquidations and sales of busi- 
nesses which were occasioned by the possible application of Section 102. It is also 
generally true that in the case of the stockholders of the companies liquidated, by 
virtue of the surtax brackets they were usually in there was no inducement to con- 
tinue to operate businesses under prevailing tax policies. I think the latter objec- 
tion would largely have been disregarded by business men if they could have pro- 
vided for lean years and adequate replacement reserves at today's price level. In so 
many instances the companies liquidated and sold are owned and controlled by 
local management, and usually excellent management from the viewpoint of opera- 
tions and the general welfare of the employees. In numerous instances the businesses 
sold were acquired by larger interests with out-of-town management. 

I would also like to emphasize, too, that, particularly in the instance of manu- 
facturing companies which I have represented, that what looked like possible un- 
reasonable accumulations of earnings at the time have now evaporated in that 
these concerns have, out of necessity and by virtue of commitments made in the 
middle 4o's, made substantial capital investments in the form of new machinery 
and plants, so that today some of these corporations are once again seeking bor- 
rowed capital. I am sure you can appreciate the very serious thinking which com- 
petent business executives and stockholder executives indulge in when commit- 
ting themselves to plant expansion and replacement programs as contrasted with 
the advantages of liquidation or sale. 

The following case history, which was given to the Institute on a 
confidential basis by one of the principals involved, illustrates in more 
detail the actual working out of the effect of the section upon business 
concentration. Such case histories are difficult to procure because the 
businessmen involved and their practitioners are reluctant to discuss 
the details of their business transactions. 

The following illustration of the effect which possible penalties under Section 
102 may have in causing the absorption of small corporations by large ones makes 
use of an actual situation, although the names of the two corporations cannot be 

A manufacturing company with a history of many years of profitable operations, 
and with a small family group owning a substantial majority of the capital stock 
and also managing the company, at the end of World War II had a net worth of 
considerably more than half a million dollars and no liabilities whatever except 
such items as current accounts payable and a small amount of current accrued 
liabilities. The company had not had to borrow any money, even from the banks, 
for many years. Cash and investments in short term government securities together 
were about three times total liabilities, and current assets were about ten times 
total liabilities. 

There was no pressure for dividends from the members of the family who con- 
trolled the company and actually managed it, as all of them had other income 
ample for their needs. The only reason for the large dividends actually paid was 
the fear of penalties under Section 102. Hindsight from a vantage point three 
years after the end of the War has shown that there had really been no danger 
of a Section 102 penalty in any recent year (unless the tax returns were examined 
and the penalty assessed almost immediately for such years) but the financial 
condition and prospects of the company at the time the dividends were paid made 
the imposition of these penalties seem probable if substantial dividends were not 
paid. The important factor in this discussion is that large dividends were actually 
paid because of the fear of Section 102 penalties. 

It had been recognized by the management of this company that considerable 


sums of money would be required in the post-war period to modernize plant and 
equipment, but it was not expected that there would be as great an increase in 
the general price level as has actually taken place. It was certainly not expected 
that the company would find itself three years after the end of the War with twice 
the working capital requirements for accounts receivable and inventories as had 
been the case before the War. Nor was it expected that there would be an even 
greater increase in the need for money for investment in plant and equipment. 

While no thought had ever previously been given by the owners to the possi- 
bility of selling the company, they were glad in 1948 to give full consideration to 
an offer from a much larger company to purchase the entire capital stock of this 
company. By the time the sale actually took place it was evident that considerable 
additional permanent capital would have to be provided, as the necessary fixed 
capital investments had not been completed and the comfortable cash position 
of several years previously had changed to the extent that there were large bank 
loans. The owners of the business were not willing under any circumstances to 
mortgage the property, and while they could have provided the necessary money 
as equity capital, they did not like to "put too many eggs in one basket." It should 
be remembered that it was not merely a question of putting the dividends of the 
previous few years back into the business; the government had taken a very large 
part of these dividends as income taxes. 

No one can say definitely that the owners of this company would not have sold 
their capital stock to the larger company if there had been no dividends (or mere- 
ly very small dividends) during the previous few years. What can be said definitely 
is that no additional permanent capital would have been required if these divi- 
dends had not been paid under threat of Section 102 penalties. The bank loans 
at the time of sale were still below the danger point; a business recession that 
would cause the banks to ask for a reduction in these loans would also make the 
necessary money available through a reduction in accounts receivable and in in- 
ventories. All-in-all it would seem that the threat of Section 102 penalties was an 
important factor in the decision of the owners to sell this company. 

The interrelated effects of Section 102, capital gains, and the estate 
tax were commented on. 

From Kentucky: 

Sec. 102 ties in closely with liquidation of corporations to get profits out at 
capital gains rate. This is not covered in questionnaire. 

From Oregon: 

I should like to cite the following recent actual cases as an example of how the 
present tax system is impeding productive investments. 

1. Two lumbermen control a corporation which successfully operates three saw- 
mills. One of the lumbermen also owns three building supply stores. He has of- 
fered the other a half interest in the stores — which are profitable — at book value, 
the terms being nothing down and letting the business pay the purchase price. The 
offer was refused, and the reason given was — "I am now in a high tax bracket. 
What I would receive net after taxes would be small, and I am not interested in 
assuming responsibility even in a small way for that kind of return." 

2. A man who has accumulated an estate of nearly a million dollars refuses to 
enter into any new ventures. He is in his late sixties and worries more about having 
enough cash to meet his estate and Oregon inheritance taxes than anything else. 

In additional comments the respondents pointed out the following 
various effects of the section: Corporations had been able to pay fair 


dividends by reducing cash on hand resulting in more borrowing. (Prac- 
titioner) Payments of dividends beyond reasonable limits had been 
compelled, with consequent reduction of available cash resources for 
improvements and expansion. If improvement and expansion pro- 
grams were adopted it meant additional debt or equity financing, 
which it was felt had a bad effect upon the economy. (Executive of 
large corporation) Section was factor in causing maintenance of 
prior dividend rate. Resultant retrenchment by way of reduction in 
operating costs. (Tax practitioner in New York) Only appreciable 
effect has been possible to advance somewhat date of making replace- 
ments and improvements over what might otherwise have been done. 
(Practitioner in Michigan) In some cases development of new prod- 
ucts has been affected by the tendency not to gamble twice, once with 
the new product sales appeal and once with Section 102. (Practitioner 
in Maine) Section has an influence on corporate dividends and also 
on question whether a business should be carried on as corporation or 
partnership, but usually there are many other factors involved in these 
decisions. (Tax accountant in New York) 


High individual tax rates have retarded payment of dividends; Sec- 
tion 102 has thus resulted in considerable expansion which might not 
otherwise have taken place; perhaps too much in some lines of busi- 
ness. (Tax practitioner in Washington, D. C.) 

One respondent reported that a friend of his with a large plant had 
added a new building which was always referred to as Number 102. 

The following case history was presented by a practitioner: 

This report covers a single company, founded in 1910 with moderate capital and 
family management. Its policy has been to pay a generous dividend from an in- 
vestment point of view (always 6 per cent and sometimes 12 per cent on the par 
value of the stock) and to plow back the major portion of the earnings into ex- 
pansion of inventory. The company's capital and surplus today are about $300,000, 
almost all of which is represented by inventory. The company does not own its 
buildings, and has not been able to reserve sufficient earnings to purchase a ware- 
house because of the necessity, so it was believed, of declaring out at least a por- 
tion of its earnings as dividends. 

The founding family is the management of the company and controls about 60% 
of the stock. The stockholders number about 25, and at least 95% of the total 
stock outstanding would be willing to forego any dividends and retain all of the 
earnings in the business, which are badly needed. Bank loans are required fre- 
quently since the assets consist primarily of inventory, which is not always liquid. 

But for the fear of Section 102, this company would retain its earnings to pro- 
vide additional working capital and to purchase its own building. Since the stock 
is closely held, however, never a year passes but what the revenue agent makes 
reference to Section 102 and says, "You had better get those dividends up." 

Fear and Uncertainty 
One accountant reports that his clients feel that Section 102 "is a 
sword over their heads," but he stated, "We feel no fear of the Sec- 


tion except in cases where obvious attempts to circumvent or evade 
are made." 

Another respondent stated: "Despite the fact that it is my policy 
to recommend that surplus be retained in the business in the form of 
expanded facilities and activities, many Boards of Directors have 
become too fearful of taking the chance." 

Another reports that corporation directors are quite disturbed by 
102 in view of "Trico." 

The president of a corporation reports that while the capital struc- 
ture of his company is such that retention in the business of a sub- 
stantial share of total earnings does not conflict with Section 102, he 
is interested in other concerns in which strict compliance with the 
provision would have seriously handicapped the development of those 
concerns. He added: 

I am personally of the opinion that Section 102 is detrimental to the develop- 
ment of business within the United States. There have been so many factors which 
affect decisions that every corporation cannot possibly carry out plans which were 
adopted six months ago or even two months ago with the result that the Treasury 
Department contends that these concerns were in violation of Section 102 through 
non-distribution of earnings. 

The whole business of running a business is so complex that any law such as 
Section 102 makes management's job extremely difficult. It would seem there 
should be some other way of finding the few cases in which earnings are with- 
held in order to avoid receipt of dividends and therefore added taxation. 

A small businessman in Ohio said that only those persons connected 
with companies realize that 102 is causing excessive distribution of 

Attitude of Treasury Agents 
Some respondents volunteered comments concerning the attitude of 
Treasury agents as follows: 

From Pennsylvania: 

One of the most vicious aspects of Section 102 is the practice which has developed 
within the Bureau of using this Section as a threat to compel a taxpayer to ac- 
cept other adjustments, which may or may not be warranted. This is no idle 
statement. Only this week this same corporation was before the Office of the In- 
ternal Revenue Agent In Charge contesting a disallowance of its accrual for bad 
debts. That was the only item mentioned in the agent's report. The conferee, how- 
ever, after fencing for two hours to compel the taxpayer to reduce its reserve to 
25% (the total accrual was less than $10,000 with annual sales approximately 
$3,500,000) said, "Well, we can always consider Section 102 and you had a pretty 
big surplus." Unfortunately this practice is general and the conferee's threat was 
not an isolated instance. 

From Michigan: 
A 102 assessment has been asserted against but one of our concerns and that 


under circumstances making the invoking of 102 absurd, as there was paid out in 
the year in question 73% of the earnings in dividends and for capital purposes 
more than the remaining 27 per cent of earnings so that in the year in question the 
surplus and reserves were reduced. 

From Practitioner in Michigan: 

Section 102 is on the surface a fair law, but by its implications and the way it 
actually works, and worse still may work, it is one of the most vicious laws from 
the point of fair taxation that a taxpayer could be faced with, unless it be a tax 
rate of over 100%. 

The unfair thing about it is that there is no equality in its administration. To 
begin with there is no formula by which an honest taxpayer may be guided. Then 
there is the fact that in most of the country the section is only a threat but there 
is no enforcement. The honest taxpayer desiring to be lawful feels he should pay 
a large dividend while another taxpayer with the same figures as the first decides 
to take a chance. He usually gets away with it and of course this is hardly fair 
to the first fellow. This is decidedly more of a pig-in-a-poke than the declared 
excess-profits tax law, now dead. May it rest in peace. 

If there is to be such a law, it should have a definite method of computation 
and uniform applicability to all taxpayers. 

From Practitioner in Ohio: 

The 70% distribution has been over-emphasized. 

From Tax Accountant of Large Company: 

The revenue agents shy away from invoking this section on a corporation whose 
stock has national distribution. I do know that the local agents are very careful 
in reporting cases of any kind under Sec. 102 because of the rebuffs they have 
received from the department heads in the Bureau. They tell me that a case must 
be air tight and be a flagrant violation of the law to get by Washington under this 

From Comptroller of Large Corporation: 

Section 102, particularly within the last four years, seems to have made a very 
deep impression upon the management in most businesses with which the writer 
comes in contact. This is due largely to the more widespread practice of Internal 
Revenue field auditors contacting top management for justification of accumulated 
surpluses. It is also due to the fact that this is purely a punitive tax. In corpora- 
tions of less than one hundred stockholders there has now developed a very strong 
tendency to declare the major portion of profits in annual dividends in the hopes 
that the individual may salvage some of his profits because of lower personal income 
tax brackets rather than the high brackets of Section 102. The fact that many 
closely held corporations, once the punitive tax has been applied, have continued 
to be harassed year after year by the Bureau of Internal Revenue has also become 
a matter of general information among businesses and they wish to escape any 
initial application of Section 102 because of possible future harassment under 
the law. 

Suggestions for Changes in the Tax Law 
A few respondents indicated changes which they thought should 
be made in the tax law. Some thought the section should be repealed. 
One suggested elimination of the double taxation of dividends. An- 


other favored integration of corporate and individual taxes, and 
commented: "This is a difficult but not insurmountable undertaking, 
and it will insure to the government its proper share of the national 
income, and it will leave to business the fundamental decision of de- 
termining when earnings should be retained and when they should 
be distributed as dividends." 

Fact-Finding Panel on Economic Effects 
of Section 102 

Introduction by Alfred G. Buehler 
University of Pennsylvania and Chairman, Panel Committee 

This is the first of a projected series of panels which the Tax Insti- 
tute hopes to conduct on the general theme of taxation and productive 
investment. Certainly an economy operating at a high level of produc- 
tion, employment, and consumption requires a high level of invest- 
ment. The much criticized Section 102 relates to the crucial question 
of investment. We have heard all sorts of discussions of Section 102. 
The effects have been denounced. Various remedies have been pro- 
posed. Some persons want to get rid of it; some want to reform it; and 
some want to keep it as it is. 

The problem of this panel, which is part of the program of work 
on Section 102 is, so far as possible, to get at the facts concerning the 
effects of this feature of the income tax. Profes- 
sor Williamson of Wesleyan University has done 
considerable work, as you know, as an economist 
for the Tax Institute study, bringing together useful background ma- 
terial. A questionnaire raising certain questions as to the effects of 102 
has been sent out. This fact-finding panel will be followed in the near 
future with another panel which will discuss policy implications. So 
the job here today is, in a sense, as I see it, one of a big game hunt, 
the quarry being the elusive facts about 102. Just how much of the 
story is fact, and how much is fiction? Is the bite of Section 102 really 
serious, or isn't there much of a bite after all? Is there just a lot of 
rumor about the bite? Professor Williamson's study, as you know, did 
not come up with very conclusive results, and as those of us interested 
in this have talked with business executives and tax practitioners we 
have been impressed with the fact that we have here one of the most 
difficult problems to explore. 



I think it is appropriate that the Tax Institute should be working 
on Section 102. It has a reputation for being impartial. It is not an 
organization promoting any legislation. Its job 
has been to try to get at the facts of taxation and 
public finance and to disseminate those facts to V ' y 

the citizens. 

I am sure too that it is appropriate for this particular group, con- 
sisting of business executives, practicing attorneys, accountants, and 
economists to discuss the facts of life — so to speak — about 102. Finally, 
I think it is appropriate that the chairman of the panel should be 
Mr. Edwin George, who is director of the Department of Economics 
of Dun & Bradstreet. He is a researcher, he is objective, and he has 
done substantial work on Section 102. That work was done, however, 
a few years ago. He comes to the panel today as chairman — I am sure 
after a number of discussions with him — with the purpose of really 
finding out what the facts are. 

Mr. George, from here on the job is yours. 

Statement of Panel Function and Procedure by Edwin B. George 
Director, Department of Economics, Dun & Bradstreet, Inc. 

Mr. Edwin George: Thank you, Professor Buehler. 

From what Professor Buehler has said, gentlemen, it seems clear 
that we have an interesting — somewhat nebulous, perhaps, but never- 
theless an interesting job ahead of us. In the 

performance of that job we have, at least, three " ereS m9 

r -j ^ • , r -t • r , Nebulous Job 

sources of aid. One is the familiarity of the 

panel committee with this type of fact-finding effort. The second is 
the excellent objective work which Professor Williamson has done in 
trying to uncover evidence for us and give us an advance idea of 
what it means and what it doesn't mean. The third, of course, is the 
strength that we can, at least, hope is contained within ourselves in 
the familiarity of the members of the panel with the law and with 
the problems that are raised by it, and their interest in it as evidenced 
by their presence here. 

There would seem to be three reasonably distinct levels of analysis 
in efforts to gauge the significance of Section 102. The first, of course, 
is the direct influence on the actions and poli- 
cies of corporations as a result of the law. The 
second is the aggregate effect, the aggregate naysis 

consequences of all of those individual actions to the economy as a 
whole, in the terms of great major functions such as production, dis- 


tribution, consumption, investment, and, rather particularly, although 
it is a little more obscure than the others, changes in the financial 
structure. The third possible level of analysis is the discovery of 
desirable public policy either within the sphere of influence of Sec- 
tion 102 itself, or with respect to possible basic changes in the tax 
structure that would tend to lessen the need for a clumsy patch of 
this kind. 

The reason I mentioned these three possible levels of analysis is 
to try to provide us — all of us — with a means of sorting out our own 
job. I would like to look at those three levels for a moment with that 
intent. With the third, the policy level, I take it, according to the 
instructions which have been given us, we have almost nothing to do. 
It is our job to develop, sort out, and pack down the facts, and then 
turn them over to another panel which will be set up for the purpose 
of considering policy. Nor has our group any formal responsibility 
for the development of a report on the second level, that is, the 
aggregate consequences, although I am sure that there is nothing to 
bar any individual member of this panel from expressing any view 
he wishes as to the good or bad public effects of the actions of corpo- 
rations which he feels are impelled by this provision. But we have 
been asked explicitly to explore the first level and to do it intensively. 
Both of the first two levels really fall under the heading of "economic 
analysis," although I think the distinction between them is plausible 
enough for our purposes. 

Professor Buehler has already talked on the question of confusion. 

It is generally conceded for one thing that the mere number of actions 

that are brought by the Bureau of Internal Revenue has very little 

value as a test of the effects of this section. It is the scale and variety 

of corporate actions that are induced by this section and the foot 

pounds of pressure — I think it is proper to say — that are put upon 

business by the Treasury Department in one way or another, that 

create the real effects that analysts have for some years been trying 

to measure and, I gather, without too much success. One reason is 

that in such an area we are dealing primarily 

with the imponderables of psychology, and I 

Imponderables . , . . . n , , „ 

suppose that almost any veteran in this nelu ol 

analysis will testify that it is extremely difficult to separate the facts 

from the rationalizations. In almost any situation a variety of reasons 

may exist for any particular action and I think we would agree that it 

is human nature to assign as much weight as possible to an irritating 



A questionnaire that the Institute has sent out gives us one frame 
of reference. These questions were carefully thought out and have at 

least the merit — the double merit I should say — „ , . 

r , . , r c , Tax Institute 

of bringing out some general tacts tor us and 

00 ° Questionnaire 

of particularizing the main complaints of busi- 
nessmen about the law. The use of a common set of issues will help 
the Institute management greatly in trying to make sense of what we 
are about to say. Now, in making that suggestion I am apparently 
raising a paradox although one, I believe, that can be fairly easily 
resolved. This questionnaire was sent out to about 1,700 people and 
has been executed and returned by about 200. What can we add? 
There are only about twenty of us. Not any significant weight, as such, 
to the mere volume of evidence that is in the panel committee's hands, 
nor in rounding out the original sample in order to give it a more 
scientific cast. We haven't been selected on that basis. 

The thought, and I believe the hope, of the committee is that we 
can add a judicial quality to the general run of evidence that is avail- 
able. I am merely throwing this out as a surges- ^ , 

7 f , . . Judicial Quality 

tion tor you to comment treely upon as an mi- ^ . . 

. , 7 c , r- . Desired 

tial, preparatory step ot denning among our- 
selves to our own satisfaction what we are going to try to do in this 
meeting. The thought I have in mind is that we can probe and test 
for accuracy. 

Professor Williamson's excellent and admirably objective study 1 
brought out very clearly the difficulty of distinguishing the part that 
102 plays in influencing corporate decisions from 

other motives and other pressures. He has been 

r , . r . . , . r Williamson's 

careful to warn us of the wide variety of con- 
siderations that might influence the rate of 

retention. I think it may be worth while to note two or three of these 
considerations listed in his manuscript, because all through our own 
discussion we shall be engaged in the effort of making the same dis- 
tinctions. He cites such outside factors as size, industrial classification, 
size of profits, rate of profits on net worth, the conditions under which 

1 This statement refers to a memorandum to the participants in the fact-finding 
panel, also referred to subsequently by others. This memorandum included certain 
background information, involving statistics, surveys of the literature on Section 
102, and certain other data. The memorandum was intended for the assistance of 
the panel members in preparing for and in conducting their meeting. It was di- 
rected chiefly at posing questions, and raising problems involved in getting and 
evaluating the facts as to the effects of Section 102. Having served its purpose, it is 
not incorporated as a part of the record for publication. 


the business is operating, such as boom or depression; and such in- 
side considerations as requirements for reserves — different kinds of 
reserves — cash for expansion and for dividends. All of these, of course, 
must be given their due weight, whatever it is, before any of us has 
any right — I suppose it is proper to say it that way — to decide that 
the residue of responsibility for whatever was done belongs to 102. 

I think it may be interesting to add to that, 
Letter from .„ . . . , , . . r 

11 it is in order, this quotation from a letter re- 
ceived from Colin Stam, Chief of Staff on the 
Joint Committee on Internal Revenue Taxation: 

As Professor Williamson says, "there has been an enormous outpouring of litera- 
ture on Section 102 .. . however, this literature yields little as to actual economic 
effects of the influence of Section 102." If your fact-finding panel can "supply the 
information and confirm the validity or invalidity of these allegations," and, par- 
ticularly, if it can estimate with reasonable accuracy "the frequency and order of 
importance of the total of each of these business results," the study may be helpful. 

I share Professor Williamson's views as to "the elusiveness of the fact-finding 
problem," and I agree with him that, although general statistics and the answers 
you will receive from the questionnaire will provide background material, the most 
useful results are likely to be obtained from the carefully screened and appraised 
experiences of the panel members. 

The thought that I have been trying to lay before you is that the 

distinctive contribution we can make is perhaps 
Contribution Panel . P , n . , ., r 

that of testing and refining the evidence, or ol 
Can Make . „ . , . . <■•.•• 

satisfying ourselves that certain types of criticism 

are overdone or underdone, or that it is not possible to do a clean job. 
The last is a conclusion we are justified in reaching, if that is the way 
it comes out. In that sense we would be testing the quality of the 
evidence rather than trying to add to its quantity. In the course of 
such an effort I should say it would be a fair proposition that what- 
ever evidence each one of us is able to lay on the table will be sub- 
ject to a cross fire of appraisal and criticism from the others in order 
to test its net content thoroughly and to free it from the outer- 
peelings of other considerations that may have gotten mixed up 
with it. 

We have the assurance of the Institute that our discussion can be 
completely uninhibited; we can speak freely, secure in the knowledge 

that we have the privilege of editing anything 
mn ' '. te we say in order to clear it of any observations 

that later we might find to be embarrassing. 
I think it is appropriate to pause here and ask you if there are any 
comments on what I have said, or any other suggestions as to the 
manner in which we should proceed. 


Discussion of Panel Procedure 

Mr. Maloney: I thought, Mr. George, at the beginning of your 
remarks that we were not to consider the collective economic effect 
of the impact of 102 on individual taxpayers. 

Mr. George: No, I am sorry. I divided the area into three levels in 
the course of a process of elimination. The first one was the effect on 
the individual taxpayer; the second one was the . 

aggregate effect on the economy as a whole with 
respect to certain of its broad functions that I 

listed suggestively; and the third one was with respect to policy either 
as regards Section 102 or reformation of the tax system generally. My 
suggestion was that the task which had been given this panel lay 
largely in area number one. As to area number two, I believe my 
words were, "There is nothing to stop anyone from offering a view 
if he wants to do so." 

Professor Buehler: I think it is apparent, Mr. George, that if the 
panel, today, got to work on the effects on the economy, the business 
cycle, secular effects and so on, it would be valuable for us, but it 
would get us away from the job that first ought to be done, and that 
is to discover the effects of Section 102, as far as possible, on particu- 
lar taxpayers and particular situations. That is the starting point. 

Mr. George: Yes, that is what I remember came out of our pre- 
liminary discussions. 

Has anybody any comments on procedure? 

I've thought it might be advisable to follow the questions in the 

Tax Institute questionnaire, but to revise question three to read as 

follows: "Were actions of your corporate tax 

. , , ii. Discussion to Follow 

clients either stimulated or retarded in some _ 

t -* ™ • t 11 1 • 1 Questionnaire 

way by 102? Please indicate which and in what 

manner, as (1) by the forcing of dividends or (2) by efforts to avoid 

distribution without penalty." That will permit us to look for either 

type of action or rather the effects of either type of action under "m" 

that appears below question three. 

Professor D. T. Smith: What was that again? Would you mind 
repeating that? 

Mr. George: (1) "By the forcing of dividends or (2) by efforts 
to avoid distribution without penalty." In other ' _,, L . , 

, T ,-ll- T 1 Eff0rtS i0 AV0 ' d 

words, I was takme the alternative cases. I have _. ., . 

.,.,., * r r Distribution 

no pride in this language. As a matter 01 tact, 

it was done rather hastily but you will see what I was trying to 

get at. 


Professor D. T. Smith: It might be better to say "even at the risk 
of penalty." 

Mr. George: There is a tang to that suggestion but is it neces- 
sarily so? I mean it would only apply to one group of situations, 
wouldn't it? 

Mr. Rudick: Isn't it "by efforts to accumulate"? 

Mr. George: Would the accumulations have to be entirely in cash 
or liquid assets? 

Mr. Rudick: Don't you mean to justify "efforts to retain earnings 
without penalty"? 

Mr. George: Yes, I think that is the reciprocal of it. Which shall 
we say "without penalty" or "without risk of penalty"? 

Mr. Rudick: "Be allowed to accumulate earnings without risk of 

Mr. George: Isn't it slightly redundant, "efforts without risk"? 

Mr. Cooper: I think your language as it stands is better, "efforts" 
is enough there, "efforts without penalty." 

Mr. George: "Efforts to accumulate without penalty"? 

Mr. Cooper: You sometimes avoid penalty without having accu- 
mulation. I like your language as it stands there, "efforts to avoid dis- 
tribution without penalty," because if you put it in terms of "efforts 
to accumulate without penalty" you leave out of the picture certain 
things that may be done such as increasing bonuses to officers and cut 
down on earnings and profits, and eliminate surplus. 

Mr. George: I agree with that. That is the reason I chose that 
for the wording. There are some kinds of action that would be 
excluded by the positive wording; you wouldn't be accumulating, you 
would merely be avoiding distribution. 

Mr. Ayers: You would be merely avoiding distribution to the 

Unidentified Speaker: Are we talking earnings or are we talking 
102? If the earnings are dissipated by excess bonuses and so forth you 
won't have any accumulations. 

Mr. George: That's right. 

Mr. Dixon: The effect on a corporation is no different whether 
you distribute it as salaries or as dividends, it reduces the corporation 

Mr. George: I added to my list all research and advertising. Are 
those eligible, as possible effects? 

Mr. Dixon: You might add "retirement of preferred stock." 

Mr. S. A. Smith: I had hoped, Mr. Chairman, that during the 


discussion we might get some additional things that would come up 
as we go over it and that this wouldn't be binding us. 

Professor D. T. Smith: In this change that you are discussing do 
you intend to omit question five entirely? 

Mr. George: I thought we could omit that, and no matter which 
way the corporation galloped we could use this as a check list as to 
what might happen. 

Under question four I would like to ask your feeling about this 
point. It seems to me there can be two distinctions as to kind of 
business. It is possible to have a generally dif- 
ferent effect on types of business by function as r „ 

„ , ,..,,.. of Business 

well as by line. So, I divided mine into two parts 

under "Kind of Business," (a) manufacturing, distributing, mining, 
service or so forth, and (1) the line, particular line. Now, again, I 
admit this is my personal work sheet. If any of you agree with that, 
we could jot it down for future reference. 

I gathered the impression from some of the things that have been 
said in the past that there was much greater vulnerability with re- 
spect to some of these broad major functions than with some others. 

Here is a question that I added at the suggestion of Colin Stam. 

He didn't suggest it as a change in the questionnaire; he raised it, 

obviously, by way of a general caveat. Under question four, add: 

"Were there one or a few predominant stock- ., , 

Number or 
holders who would be affected, taxwise, by a _ , , , , 

ii j- -, • -,» T i_ j Stockholders 

greater or smaller distribution? In other words, 

the implication is — you can check me on this — that it is not enough 
to know the number of stockholders, that you really have to know 
something about the distribution to determine the degree of vulner- 
ability to attack. 

Mr. Turner: Well, if you have less than five, you really have the 
answer, don't you? 

Mr. George: I suppose so. 

Mr. Turner: If you have five to ten, then you might ask the 
question, "Is a majority of the stock controlled or owned by one 
particular person or a family?" 

Mr. George: Yes. 

Mr. Rudick: What he has in mind is a situation like the Trico 
case where you have several thousand stockholders but one small 
group controls the corporation. 

Mr. Turner: That is what I mean. 

Mr. Cooper: I doubt if that would apply until you get over a 


hundred. Take any company even up to a hundred and you usually 
find that there is a small group that controls anyway. 

Mr. Dixon: We had a case where there were three or four hun- 
dred stockholders and where close to two-thirds of the stock was in 
the hands of one family and only one-third was held by other stock- 
holders, so that the number of stockholders really does not apply. We 
have many cases of that type. It is really surprising how many cases 
you run into where there are many more stockholders than a hundred 
and where the control is concentrated and the surtax would apply to 
a very small group of individuals. 

Mr. Cooper: I would say where there are two hundred you are 
pretty certain to have control closely held. 

Mr. George: Then you think it would be just as well to have 
this question in? 

Mr. Dixon: The pertinent question under number of stockhold- 
ers is, I think, "number of stockholders holding control," that is, con- 
stituting control. There would be the effect on the surtax, where you 
come under the avoidance of surtax. 

Mr. Rudick: What do you mean by "control"? 

Mr. Dixon: I would say 51 per cent or greater. 

Mr. George: Would you accept "dominant position" for control? 

Mr. Cann: I think you have to accept "dominant position." I can 
think right now of many corporations where dominant position is held 
by probably less than 20 per cent, but of that 20 per cent there would 
be one of them in the exceedingly high surtax brackets. There isn't 
any question that any substantial distribution would affect their tax 
liability so materially that they would be opposed to any dividends. 

Mr. George: Well, all we are doing is settling on definitions for 
our own purposes and is it agreeable to everyone to use "dominant" 
with respect to that question? 

Mr. S. A. Smith: Isn't there one more point, Mr. George? Doesn't 
it make a difference whether the dominant stockholder is active in the 
management? Because today so many of your men in that position 
are able to take their money out in other forms. I mean some of them 
have yachts on which they do entertaining — for the company, of 
course, just use it weekends for their own business or pleasure and 
that sort of thing. But doesn't that make a difference, hasn't that been 
increased by 102, amongst other factors? 

Mr. George: You had in mind particularly the medium-sized or 
small corporations? 

Mr. S. A. Smith: Yes, the small ones. Don't you feel that even 


though the dominant stockholder is not an active member of the 

management, nevertheless he is consulted before the final dividend 

action is taken? I was thinking of all of the effects of what happens 

to the cash earnings of the corporation. Now, if _ . . . „ 

, , , , . r Dominance in Small 

the dominant stockholder is a member or the _ . 

, ... Business 

management and active in it, then he is in a 

position to take advantage of all these other ways of taking money out 

of the business and avoiding taxes — to some extent anyway. If, on 

the other hand, he is not an active member of management, then it 

is going to be very difficult for the company to give him a yacht or 

an automobile or a house or what have you. Isn't that true? 

Professor D. T. Smith: It seems that that is an additional effect 
that you are raising there as to the relative attractiveness of executive 
activity in a small business on a salary job and a large proposition. 
There seems to be some difference of opinion, but also some evidence 
that there is some advantage in a relatively small setup. 

Mr. George: Is there any particular set of words you want to 
adopt in regard to it or just keep it in our minds? 

Mr. S. A. Smith: I just threw it on the table to see what the gen- 
eral opinion was. I think it should be considered. 

Mr. Ayers: Isn't that an elaboration that comes out in the dis- 
cussion? Going back to Mr. Cann's statement on dominance, a great 
deal would depend on the distribution of that remaining stock. Let's 
assume 51 per cent control, for example. If you have a listed stock 
you have all of the other policy problems that will force a dis- 

Mr. George: All right, let's just leave it there; everybody is aware 
of it. 

One thing I did have in mind was that we ought to help the Insti- 
tute. Maybe my ideas of helping them are very crude, but I think 
we at least ought to be very clear about the kind of case that is under 
consideration when we discuss the effects, and the only way to be 
clear for a permanent record is by establishing our characteristics in 

I shall leave the introductory remarks to our friend and accountant, 
Maurice Austin of Klein, Hinds & Finke, of New York. 

Statement by Maurice Austin 
Klein, Hinds & Finke, New York 
Mr. Austin: Well, to start the ball rolling, I am reasonably sure 
that, despite what we would like to accomplish, we are not going to 


get anything in terms of precision or measur- 
Impossible to Get \ . L. & T _ , . . *V , , . , , 

n . , able effects. I would be inclined to think that 

Precise and _ , . „ 

, , „,, the only economic effect that would be reason- 

Measurable Effects . , ' . _ _ _ . , , _ , 

ably determinable and measurable would be on 

the tax practitioners. 

There has been a considerable amount of talk by many people, 
including a number around this table, of various effects upon dividend 
payments and fixed asset expenditures and a number of other things. 
There is certainly some measure of truth in all of these. It is unques- 
tionable that — I base that on direct experience and the experience of 

_. . , . others with whom I have had discussions — there 
Excessive Dividend . . .,..,, 

nave been excessive dividend payments in some 

cases out of fear of 102, with possible results in 
the future. There has been a certain measure of stimulation to fixed 
asset expenditure with, perhaps, effects upon the inflationary condi- 
tion during the last few years. There has been some measure of effect 

_, . , upon the fixed asset situation by reason of plac- 

Placing of . r _ , . . . _ . > r , 

_ ... ing 01 orders with a view to building up a record 

Questionable & , _ . . , . r 

as a defense against 102, the actual execution 01 

which in a number of cases may be questionable 

when dollars have to be put down on the line, particularly in view 

of the large rise in price. 

There certainly has been — I would say probably among the widest 

effects, although perhaps not the most important — a considerable 

practice of creating nonliquidity on balance 

kI ,. ... sheets at the end of the year, as of which date 

Nonliquidity J ' 

the balance sheets are made up that show up 

in the tax returns, nonliquidity in the form of increased amounts of 
receivables, inventories, debts. 

There has been a certain tendency to convert corporations into part- 
nerships in those cases where the tax situation of the people involved 

makes that feasible. Particularly has that been 
Conversion of . . _ . , y 

_ so in the case 01 relatively new corporations 

Corporations . . ■ ' r . 

which came into beinsr with the repeal 01 the 
into Partnerships _ _ ° . _ . r 1 

excess profits tax and where sudden large and 

unexpected profits have caused hastened action toward distribution 
in the form of liquidation of the corporation in order to avoid Sec- 
tion 102. 

There has been some effect in the way of causing owners of busi- 
nesses forming new corporations to finance by loans to the corpora- 


tion — debt structure rather than capital or equity structure. There 

has been some retardation of growth of corpora- ^ . . . , 
, , , 1 , • Deb * Instead of 

tions, but I would venture to say that the biggest m . 

a- .,,.... / , Equity Capital 

effect in that direction is with respect to rela- 
tively small businesses of the type which do not immediately plow 
back their earnings into their business but build them up in the form 
of free cash reserves against future, presently undetermined, contingen- 
cies either of expansion or of unforeseen adverse developments. 

I think it is perhaps important to note that the effect of Section 102 
varies considerably with the business conditions that we are facing. 
I think it is fair to say that, compared to the amount of conversation 
about this subject that has been going on in the recent past, there 
was relatively little heard about Section 102 in the years before the war. 

I think that at the present time there is comparatively little heard 
about Section 102, at least as compared with what the situation was 
several years ago. Obviously, the combination of the repeal of the 
excess profits tax and the lifting of price ceilings and the general stim- 
ulation caused by the holding back of civilian-use production, caused 

tremendous, and, in some cases, unexpected, 

~ . ,, , , . , , Widespread Fear 

profits m 1946 and 1947 which caused a great 

deal of fear of Section 102, particularly stimulated by the announce- 
ments of Treasury policy, and that famous question on the 1946 
return and the resultant flood of literature. 

In addition to the fact that a number of corporations have made 
less money and some have lost money, one of the changes which I 
think has caused a certain drop in the volume of talk about Section 

102 recently has been the change in Treasury _ . T 

, - . . _, ' Change in Treasury 

attitude or at least it appears that way. Cer- ... 

. , f . , . ,. • r Attitude 

tainly the experience to date in application of 

Section 102 to such 1946 and 1947 returns as have been examined 

seems to be a good deal less formidable than originally feared. 

So far as experience and inference from experience would show, I 

think it would be pretty clear that the effect of Section 102, such as 

it is, is the least on industries which have heavy capital investments, 

which are heavily debt-financed, those which have low turnovers of 

inventories or of receivables, those which are 

engaged in manufacturing as distinguished from 

1 r . . . 1 r itt Affected 

other types 01 activities and, of course, publicly 

held industries. On the contrary, of course, the effect will be greatest 

on light industries, on debt-free industries, on those which are 


engaged in jobbing and distribution and service activities, those which 
have high turnover of inventories and receivables, and those which are 
closely held. By closely held I mean that dominance or control is 
closely held by a group. 

Undoubtedly the greatest effect of Section 102, such as it is, is in 
what I might call its fear effect, obviously not manifested in the 
number of cases that the Bureau or its repre- 
sentatives will bring up as Section 102 issues, but 
rather in the uncertainty of how the Bureau will administer the 
Section and resulting decisions, which perhaps are not warranted by 
the ultimate event. And, secondly, and I think very important, the 
fact that the courts have been building up or seem to have been 

Doctrine of Immediote *™ ild j«g U P- » «". with certain variations, a 
doctrine of requirement of immediate need. In 
other words, the accumulation of earnings is 
justified by expansion and other requirements only if those require- 
ments are reasonably definite and immediate in point of time, with a 
consequent inhibition of natural accumulation of earnings against 
general and undefined future needs for growth or contingencies. As 
I mentioned before, the effect generally would be greatest on rela- 
tively small businesses which do not have a history behind them. 

Generally speaking, I would say that the tax practitioners' experi- 
ence with Section 102 would be rather deceptive in the validity or 

reliability of the conclusions to be drawn there- 
Practitioners' _ ' . . .„ , 

from. A tax practitioner will have the greatest 
Experience . r . ° 

experience in those cases which are in trouble 

or think they are in trouble under Section 102, and one tends to get 
a somewhat unbalanced picture in that direction. I am talking from 
the point of view of the one who specializes in tax work. A more bal- 
anced picture, perhaps, is obtained from a general accounting practice 
where you have a mixture of concerns, those that have no problem 
under 102, those that make money, those that make less money and, 
of course, those that do have Section 102 troubles or think they have. 
I have not as yet answered this questionnaire — my firm hasn't. It is 
somewhat of a job to get up these data, if they are to be at all reli- 
able. Just speaking in terms of general estimate, with the experience 

.■--.. of about koo corporations, more or less, I would 

Proportion of Clients , . ■ , / -, * ^ 

say that in the years 1946 and 1947 we probably 

considered this problem in 50 per cent to 60 per 
cent of the cases. Out of the total, however, I would say that care- 
ful study was necessary only with respect to about 15 per cent or 20 per 


cent of the cases and in about 10 per cent of the cases something was 
done, either in the way of increased dividend distribution or decision 
of the company to enter into various projects, whether new products 
or expansion of facilities or something of that nature. All of these 
figures are down sharply for the years 1948 and 1949. 

Generally speaking, I would be inclined to think that the effect is a 
good deal less than the great flood of literature in '46 and '47 would 
seem to indicate. In those cases which are af- 
fected the effect has been rather marked. As 

to its general effect, I am a little dubious about its over-all impressive- 
ness. That is entirely qualitative, of course. 

This statement hasn't been very well defined in terms of precision 
or measurable statement but I have tried to get the ball rolling. 

Discussion of Statement by Maurice Austin 

Mr. George: I think you succeeded in doing that, particularly in 
your closing effort to tie things together into a general impression that 
you don't think the effect has been substantial, but that when there 
has been an impact it has been rather severe. Is that right? 

Mr. Austin: I would say so. I think perhaps I should add one other 
situation. In those cases where certain steps have been taken either 
in a modest amount of increase in dividend payment or in laying out 
a program for expansion in the hope that that will be sufficient to 
ward off adverse effects — in a number of these cases, how many I can't 
say, corporations are now sitting around waiting for the ax to fall 
and hoping it won't. What the actual effect of 
that is on an over-all basis I don't know. Again, am P emn 9 
in individual cases it has in that type of situa- us,ness <= lvl y 

tion a dampening effect on activity because funds can't be irrevocably 
tied up where they may have to be paid out in Section 102 taxes. 

Mr. Moloney: Mr. Austin, are you in a position to classify the 
corporations which were heavily affected as to whether they were per- 
sonal service corporations, manufacturing corporations, large corpora- 
tions, or small ones? 

Mr. Austin: Well, in terms of the size of the company I wouldn't 

draw lines particularly; the very small usually are not too greatly 

affected. By very small I mean where you are 

getting down to under $20,000 of income. I don't A „ . 

think there is any limit on size in my experience. 

I think that what is more to the point is the distribution of stock- 
holdings. In terms of type of industry in this area, the New York area, 


it has been quite notorious that the textile industry, for example, in 
1946 and 1947 were making fabulous profits and had tremendous 
liquidity and they had a serious Section 102 problem. Maybe it is 
one they should have had. 

Mr. Sibley: But they didn't pay out a very large percentage in 
dividends despite the profits and the earnings. 

Mr. Austin: I think that is true in a number of cases. I think that 
they decided that if something had to happen, perhaps Section 102 
was the lesser of two evils. 

Mr. Turner: In the case of the textile companies, they had a lot 
of red ink and their surplus was probably dissipated so they really 
needed some of these years to get some of it back. 

Mr. Austin: Well, in those cases I don't suppose they had too 

much of a problem. I am thinking of a number of situations where 

. people bought mills during the war period and 

then they suddenly found that the marginal 

mills could make a tremendous amount of 

money because of shortage and they piled up very considerable 

amounts of cash, which they have given back since then by reason of 

losses from drops in prices, but, of course, that wasn't entirely evident 

in '46 and '47. 

I think I might add that there was some feeling that perhaps ac- 
centuated the situation — whether there is truth in this, I don't know 
— but there certainly was an impression stirring abroad that the 
Bureau felt in 1946 that repeal of the excess profits tax was somewhat 
premature and that, coupled with high profits 
resulting from the demise of OPA, brought about 
a situation in which the Bureau in certain cases substituted Section 
102 for the excess profits tax. I put that, perhaps, in a rather crude 
way but there was a certain amount of feeling that that policy ex- 
isted. Whether it is true or not I don't know, but it is a feeling which 
existed and had its effects. 

Mr. George: You put it clearly enough. Of course, you are raising 
a complicated question there that I am sure lies outside the bounds 
of our discussion and wouldn't have to be decided. It raises the 
question: Could the Bureau of Internal Revenue at that time have 
anticipated the great wave of expansion and also the great inflation 
the country was going to endure, bringing with them a correspond- 
ingly increased need for funds by all concerned? Also there is the 
fact that these things all hinge on each other. If we had had the 
excess profits tax at that time we would have had a diminution of 


the funds that were going into the market and adding to inflation so 
these things can't be settled by any simple formula. 

Are there any other questions you wish to address to Mr. Austin? 

The main impression, Mr. Austin, that you are leaving with us is 
that you do not think the economic effects have been very general or 
profound but there is always a problem for the individual, that fear 
has been one of the principle influences in the situation, and that 
occasionally real hardship has resulted from the corrective action the 
corporation felt to be necessary, but that the effects were not devastat- 
ing and the Republic is not tottering? 

Mr. Austin: Well, the last is certainly true. (Laughter) 

I hesitated to make the comment I am about to make, but some- 
how I am led to add it, and that is, that I would say that one of the 
features of Section 102 that is rather bad is that it merely adds to a 
general pattern in our federal tax laws in their present condition and 

interpretation which creates a measure of un- 

• • ii r 1- r ,j , , Adds to Pattern of 

certainty m all sectors of the tax field and the . 

determination of tax effects of business decisions. _ , 

, . . , . , , Tax Laws 

So much so that in a surprisingly wide area the 

best that a tax practitioner can do is to tell the businessman: "Well, 

if you do this there is this risk, that risk and the other risk. If you do 

something else, there again is a set of risks." And when you are all 

through there is no well-defined answer as to what will happen, but 

merely a problem in choice of risks which, to a certain extent, is an 

inhibitive factor and one that I doubt will ever be measured. In that 

sense you will have a bad condition under Section 102 which is 

different only, perhaps, in degree from a number of other things we 

have in our tax laws. 

Mr. George: I think that is a rather fair statement myself. Actu- 
ally it would apply to quite a number of laws, particularly those fea- 
turing a strong subjective or judgment element. That remark is not 
intended to be captious. Explicit law in those situations could easily 
be worse. 

Is there any comment on what Mr. Austin said in his main address 
or subsequent observations? 

Mr. Cann. 

Statement by Norman D. Cann 
Cann and Long, Washington 
Mr. Cann: Mr. George, this subject intrigues me a very great deal. 
In the first place, having been in the Bureau a great many years, I was 


rather familiar with the Bureau's approach to the subject. Within 

six months after I had left the Bureau in the early part of 1946 I 

had a great many inquiries from various types of corporations on this 

problem of 102 which bears out Mr. Austin's remarks that in the 

years '46 and '47 there was much more interest 
General . . , . ;", 

m the subject. There was great apprehension on 
Apprehension . J „ A r 

the part oi corporate management with respect 

to the penalty provisions in the statute and to some extent on the 
part of local accountants who had what I regarded as a rather unwar- 
ranted fear of Section 102. This fear was aggravated by this so-called 
70 per cent question which was discussed in the latter part of '45 
while I was still in the Bureau. Personally I thought it an unwise 
question; it was prompted by the fact that the excess profits tax had 
gone out of the picture and that therefore there would be the natural 
temptation on the part of management not to distribute the profits 
into the economic stream of the country with a resulting loss of 

I would say that of these various people who came to see me in 1946 

and 1947 that less than 5 per cent of them had a real 102 problem. An 

examination of their last balance sheet would 

, M n ,, generally disclose no nonbusiness assets. It 

102 Problems ,,-,., 

would disclose m many instances there were 

commitments for plant expansion or replacement. The matter of 

enforcement by the Bureau is best borne out by the statistics which 

were presented in the paper furnished us. 

The Bureau, unquestionably, has rarely imposed the penalty pro- 
visions of 102. Yet it has been said in voluminous writings on the 
subject which have come out of Washington, supposedly having the 
low-down on administrative concepts or ideas in the tax enforcement 
field, that the taxpaying public could anticipate very strict applica- 
tion of 102. You will therefore gather that I think too much has been 
written on this subject. On the other hand, I cannot fully agree with 
the view that too much has been said about the subject by tax prac- 
titioners or by lawyers with a tendency unnecessarily to alarm the 
businessmen of this country. I take a somewhat middle-of-the-road 
position, largely based on my experience of the last four years. 

It is my view that looking first to the small closely held companies 
— I might even classify them in many instances as family corpora- 
tions — that they have increased their dividends in most instances. 
Others have indulged in such practices as increasing the amount of 
their inventories at the close of their taxable period, in many instances 


making purchases in the market which were probably substantially 
liquidated after the first of the year, particularly in the textile field — 
cottons and woolens. I regard as rather foolish efforts to try to camou- 
flage the corporation's true picture by the issuance of stock dividends, 

setting up of reserves which, on analysis, meant 

,..., .,. T ^ in- Induces Undesirable 

little or nothing. It seems to me that Section 102 
., , . , , , ... ,, Business Policies 

induces undesirable business policies and that 

something ought to be done about it. From an economic viewpoint, it 

doesn't seem very sensible for concerns, at the close of their taxable 

period, either fiscal or calendar year, to go into the market and make 

what I regard as very substantial market commitments for purchases 

of raw material. 

I would say that many of these closely held companies have given 

serious consideration by virtue of the implications of 102, considered 

together with the capital gain situation, to either , 

4.u v -j *• i r „u • i_ • t Liquidation and Sales 

the liquidation or sale of their businesses. I 

would say that over the past four years our office has participated 
in rather a substantial number of sales of businesses, particularly 
in the closely held field where the owners were prompted to sell 
by 102, and likewise the purchasers were prompted to buy by 102. 
That is to say, going back again to Mr. Austin's remarks, partic- 
ularly in the textile field, some of the larger operators having ac- 
cumulated very substantial profits decided that a possible good defense 
against 102 was to purchase additional plants. 

Mr. George: Would you say "a very large number of cases"? Ex- 
cuse me for interrupting. 

Mr. Cann: I would say a very substantial number of cases; a sub- 
stantial number, you understand, of cases handled by my shop. I 
don't mean by that, of the entire economy. 

Mr. George: Would you care to indicate the area? 

Mr. Cann: I would say principally the manufacturing and a num- 
ber of them in the textile field. 

I don't want to bore you people but I would like to tell you of a 
particular example — a medium-sized company, 62 per cent family con- 
trol with 38 per cent widely held. This particular company had experi- 
enced substantial peaks and valleys over a period ,, . „ . . 
c , . , . 1 .,.»,,, , Unwise Capital 

of thirty years during which it had had the same 

management-control. It made very substantial 
profits during the war and in the years '46, '47, and '48. About the 
middle of '47, it was quite apparent that they were going to continue 
to enjoy large profits. Their accountant had advised them that, in his 


opinion, there was a possibility of Section 102 being asserted. This is 
a textile manufacturing company. The management of this business 
having experienced sharp declines in earnings at times over its history 
had found it necessary to convert its manufacturing processes several 
times which called for substantial capital commitments by a medium- 
sized company. Having 102 in mind, they decided to authorize the 
expenditure of about 11,500,000 for the renovation of machinery, re- 
placements and betterments. They were then advised by their ac- 
countant that that wasn't adequate merely to have the board of 
directors go through the motions, that in the light of certain decisions 
of the courts it was necessary to have a formal commitment. So they 
made formal commitments for $1,500,000 worth of machinery and 
equipment. At the time they did this they were in splendid financial 
condition, very liquid. Well, today, that same company, having ex- 
pended its money for new machinery and equipment on a very high 
market, is now definitely short of operating capital. Now, that, to me, 
is one of the clearest cases that I have seen of the implications of 
Section 102. Now, it is true they would have had to make certain 
machinery changes anyway, there is no question about that; their 
plant had to be modernized, although it could never be characterized 
as a marginal mill. But certainly they were prompted to make exces- 
sive and unnecessary capital acquisitions at what I regard as a rather 
bad time. Such changes should have been spread over a much longer 

I would now refer to three particular larger manufacturing corpora- 
tions that sold out in the year '47. They were home-owned, home- 
managed, with a very splendid management record. They were the 
type of management that was greatly concerned with the welfare of 
its employees. It was well known that they had operated their plants 
during depression periods when other manufacturers in the same in- 
dustry had either curtailed or possibly even shut down. During the 

, „ . years immediately preceding the World War II 

Sales of Businesses 

and thereafter, they made substantial profits. 

They knew that their various plants would need a great deal of mod- 
ern, new equipment. Management didn't feel that they should make 
formal commitments at the then prevailing price levels. At the same 
time they were seriously concerned with the implications of Section 
102 because their current asset position had very materially increased 
although they had no nonbusiness assets. 

These particular companies had management-control but with very 
substantial minority, nonmanagement stock interests. The viewpoint 


of management not only considered 102. I should state in fairness that 
they also gave consideration to the trend of labor practices and the 
management group also gave consideration to their own tax position. 
But I would say that 102 was a very substantial contributing factor 
in their determination to sell because they felt they had certain periods 
ahead of them — based on experience — which would call for substan- 
tial expenditures and capital. They felt they were in a field of busi- 
ness which had a capacity greater than domestic consumption. Giving 
due weight to these various factors, nevertheless I would characterize 
the 102 factor as the one that led them into making a decision to sell. 
Now, they sold to foreign management — good people, no doubt — 
but it is my feeling that in our economy locally- 
owned business is highly desirable and should 
be preserved. So you will gather from what I F ° reign Enterprise 
have said there that I do feel that 102 is a contributing factor in the 
acquisition of smaller businesses by larger businesses. 

1 should also like to touch on, in connection with that point, so- 
called nonbusiness assets in the case of manufacturing plants having 
large investments in depreciable assets. Many business men, both when 
I was in the government service and since, have talked with me with 
respect to funding depreciation reserves with what might be de- 
scribed as nonbusiness assets; I have always been rather sympathetic 
to that; it seems to me it is rather logical that 

some provision should be made for replacement Deterrent to Funding 
other than mere book entries. I think 102 has Deprec,at,on Reserves 
been a deterrent to such a policy. A business with depreciable assets 
should be permitted to accumulate that type of a reserve fund. 2 

2 Editorial Note: Quotation from letter of Paul F. Myers of the Washington 
law firm of William, Myers and Quiggle to editor, May 9, 1950: 

For upwards of 20 years it has been my contention that in determining the 
applicability of Section 102 of the Internal Revenue Code or similar provisions of 
prior Revenue Acts, a corporation should be permitted to fund its depreciation 

Briefly the basis of such opinion is that depreciable property is a wasting asset. 
If the amount of depreciation sustained is not set up in a separate fund, either in 
cash or liquid securities, then the depreciation is in fact nothing but a paper re- 
serve. When the day comes to replace the worn out property there will be no 
money to replace it if such money has been distributed either in the form of divi- 
dends or invested in brick and mortar in the form of plant expansion. From an 
economic viewpoint, you might just as well not have a reserve if you are not going 
to fund it. Furthermore, the accumulation of cash and liquid securities for funding 
a depreciation reserve is not in fact an accumulation of earnings and profits, but 
on the contrary is an accumulation to offset a deduction, that is, an expense sus- 
tained but not yet paid for in cash. 

I think the point is easily illustrated if you take the case of a corporation that 


Departing for the moment from more closely held companies, I 

would like to touch a little bit on the large, major corporations. I 

don't know, of course, so much of the detailed facts with respect to 

any decisions of the directors regarding dividends but I do know this: 

that, of the various large corporations with whom I have had contact, 

many have asked me or some of my associates the question, "Where 

are we from a 102 viewpoint, in the light of our earnings, our dividend 

declarations?" Many of these major corporations 
Effect on Large . . . , * .. . * c 

have had to ero out and secure additional nnanc- 

ing in the form of long-term insurance loans or 

bank loans. Now, as I say, I can't state — I really don't know — to what 

extent 102 influenced their dividend policies. However, I do know that 

in at least 75 per cent of these companies they did increase their 

dividends in the years '46 and '47 and '48. It is likewise true, how- 

has capital paid in which is invested in depreciable property. Certainly the amount 
of cash to cover the depreciation reserve could not in such circumstances be an 
accumulation of earnings and profits. In fact if such cash were distributed in the 
form of dividends, assuming all income had been distributed, it would be a dis- 
tribution of capital. The situation is not generally so apparent, since many times 
the question does not arise until a corporation has accumulated a substantial sur- 
plus and expanded its business, but the basic principle is not changed because in 
those cases the previously accumulated surplus has in fact been used as a perma- 
nent investment in the business by being converted to depreciable property. 

Presumably such view has been favorably accepted by at least some of the offi- 
cials in the Internal Revenue Service, since during these many years I have not 
once been called upon to defend this position in Court. There is, however, Court 
authority to support this position. The first of these cases is that of /. E. Baker 
Company, a Memorandum Opinion in the Board of Tax Appeals, Docket No. 
87758, in which the decision was entered on June 6, 1939. The case is reported in 
Volume 8 of Prentice- Hall, BTA Memorandum Decisions at Para. 39257. This 
particular point is not so evident from the findings of fact or the opinion, but the 
position was strongly argued by the petitioner's counsel in his briefs. The taxpayer 
submitted evidence that certain investments were for the purpose of building up a 
funded reserve for depreciation and depletion which would be available for replace- 
ment of exhausted properties and worn out plants. Government counsel in its brief 
made no direct reply thereto. I think that the contention made by the petitioner 
that depreciation reserves are merely accumulations of wasting assets and that the 
preservation of funds to replace those wasting assets is not an accumulation at all 
and cannot improve a company's financial position, is sound. 

The above view is also supported by the case of Steele's Mills v. Robertson, 
decided by the United States District Court for North Carolina in 1943, and re- 
ported at 32 A.F.T.R. 1734. The Court stated in part, as follows: 

"The Court finds as a fact that it was in accordance with sound business prac- 
tice and a reasonable need of the business of the plaintiff to withhold from dis- 
tribution to its shareholders assets in cash, Government bonds or other liquid form 
sufficient in amount to equal its reserve for depreciation for the purpose of having 
the funds readily available with which to replace machinery and other items in the 
plant account when they become obsolete or worn out and it is profitable to dis- 
card them." 


ever, that most of those companies still carried to surplus after the 
payment of dividends a greater amount than they had in any year 
preceding the World War II. 

Mr. George: Proportionately? 

Mr. Cann: Yes. 

I can think of one instance right at the moment of a very large 
company that increased its dividends in 1948; a company on the Big 
Board. They are paying out, I think, better than 70 per cent of their 
earnings in dividends. They have very fine management, a rather 
large legal staff with a very competent general counsel, a former tax 
practitioner. We have had serious discussions as to whether they 
shouldn't be paying out even more than the so- 
called 70 per cent rule which most people feel F ° rcin9 ° f Dividends 
is, more or less, to be regarded as applying to closely held companies. 
I feel that in such an instance — this company was an expanding com- 
pany both in the United States and abroad— it doesn't have to con- 
cern itself at all about the impact of 102. Nevertheless, these people 
are quite familiar with the law, they are familiar with the administra- 
tion of it, yet there is apprehension on their part which, again, I think, 
ties in with what Mr. Austin said a little while ago in respect to the 
general attitude of business. So I feel this, that there have been in- 
stances where 102 has been responsible for the payment of dividends 
which otherwise wouldn't have been paid. I would say, in my experi- 
ence, not more than five per cent. I might say that 10 per cent to 
15 per cent might increase their dividends for the same reason. 3 

Incidentally, my experience includes a fair-sized group of corpora- 
tions, I guess, in the New York area. Mr. Austin, I don't know whether 
your experience coincides. 

I would say, in my experience, that most corporations have given 
consideration to the impact of 102 and have concluded that it had 
no application. I would further say that some 
of these companies may have indulged in prac- UnS ° U " d BusinesS 
tices to which I have previously referred, that is, Practices 

buying substantially of raw materials, trying to increase their accounts 
receivables, and in some instances they have even arranged to defer 
collections of rather substantial amounts, all of which may not have 
so much bearing from an economic viewpoint but certainly produces 
unsound business practices. 

I think that, for the moment, at least, is all I have to say. 

3 See page 51 for clarification of this point. 


Discussion of Statement by Norman D. Cann 

Mr. George: That is a very good account, Mr. Cann. 

I wonder if it wouldn't be advisable, in order to get around the 
table, for us to try to limit ourselves to statements of basic position 
using cases for illustrative purposes as briefly as possible. I haven 
the heart to cut anybody short so it is largely a matter of self-disci- 
pline. I think the two accounts we have just had have been extremely 

Before we proceed to the next, are there any questions? 

Mr. Cooper: I have one in connection with one of Norman's ref- 
erences to the larger companies. I should like to know if he has run 
into the situation I have had in several cases which is sort of an in- 
direct effect of 102, where the directors were concerned not so much 
with whether the corporation might be subject to a penalty tax but 
whether under the Trico Products settlement they might be stuck 

„ , , ... , „ . personally by reason of their action if the corpo- 

Stockholders' Suits r . , . -, , , , 

ration was stuck with 102 penalty tax and then 
and Directors 

, some stockholder comes along and says "You are 

Liability ., _ _ •■,.-, 

responsible tor the company being stuck; you 

pay it"? I think sometimes that is more important than whether the 

company gets charged. In other words, it makes 102 doubly important 

in that sort of a situation. 

Mr. George: Do you think that influence is frequently present? 

Mr. Cooper: Well, I know of two cases where that was one of the 
things they were afraid of. 

Mr. Austin: Well, that might apply in any case where you have a 
substantial minority interest. 

Mr. Cooper: He mentioned larger companies; that is what I was 
speaking of. 

Mr. Cann: I have run across that in several instances. 

Mr. Kurzman: Maurice spoke of the substitution of Section 102 

for the excess profits tax. There was one unfortunate development 

that went with that substitution. I think there would be no liability 

charged to directors in connection with the excess profits tax. Section 

102 immediately brought the question of the stockholders' suit into 

the picture. 

Mr. Cann: Mr. George, I would like to men- 
Acquisition of Small . , T P , . ^ n . 

tion once again that I feel that Section 102 is a 

° contributing factor to the acquisition of small 

businesses by large businesses, which I regard as highly undesirable. 

Mr. George: I was interested in your stress on that point although 


it seemed to lead to some sort of a stalemate because you cited these 
companies which had accumulated considerable cash, liquid reserves, 
and explained, as you reiterated now, that they eventually found it 
to their advantage to sell out rather than to keep up what to them 
was an unequal struggle. At the same time the original motive of 
those corporations was to avoid surtaxes, I suppose, in many cases. 

Mr. Cann: No, I ought to make myself clear; I didn't say that the 
motives to avoid alone prompted it. Let's put it this way: there was 
no planned tax avoidance. They were afraid that 102 would be as- 
serted; they didn't consider they were liable. 

Mr. George: I mean as to the time of original accumulation, what 
was the ruling consideration in their minds; what was their purpose? 

Mr. Cann: Of accumulation? 

Mr. George: At the time it happened. 

Mr. Cann: Their purpose of accumulation was definitely to pro- 
vide for the improvement of plants' facilities, 

and what every businessman fears, particularly in 

. , . . , , Depression 

certain industries, is that sooner or later you are 

going to hit one of these valleys and they want to be in a financial 

position to meet it. 

Mr. George: Let's regard it merely as a coincidence, but I suppose 
in many of those cases the surtax also influences the adoption of that 
policy. So is there a proper answer as to the position that ought to be 
taken by the administrative officer? 

Mr. Cann: Of course, I would feel that any 

business, during a profitable period, should be „ 

, . . r r r . , Expansion 

accumulating earnings tor future expansion and 


Mr. George: Even though there is no immediate purpose? 

Mr. Cann: Yes. Coming back to what Mr. Austin mentioned and 

he was, I know, thinking particularly of one case or maybe two cases 

where the Tax Court has said there was no 

,. , . _ ,. , _ Difficulties Caused 

immediate need. As a test tor immediate need I 

threw out that example which was a very bad 
, . r . . . T ' Doctrine 

thing trom an economic viewpoint, as I see it. 

You go in for a firm commitment which means binding contracts in 
order to be able to satisfy the Department when it makes its investi- 
gation that you are not merely throwing up a windmill here, that 
you will have a real need in the near future for the accumulated 


Mr. George: Well, it does bring out pretty clearly that the issue 
of immediacy is one of the tests of a justified retention of earnings. I 
imagine from my own past study of the subject it is very difficult to 

Mr. Sibley, may we hear from you. 

Statement by George Sibley 
General Counsel, E. R. Squibb & Sons 
Mr. Sibley: I'll try to be brief. It seems to me that Section 102 
is such an unsound means of forcing the largest possible taxes either 
through psychological coercion or assessment that it is difficult for 
some of us to avoid mere condemnation. We must recognize, how- 
ever, that unless we can prove it produces undesirable results the 
case against it may not be impressive. 

Very few large corporate enterprises, as we all know, started other 
than as small enterprises. If, as many of us believe, the section dis- 
courages small enterprises, then it necessarily discourages the develop- 
ment of sources of employment and investment of risk capital, and is 
bad for our country. 

The problem posed by the section is constantly before manage- 
ment, in my experience, yet I am inclined to think it is less of a head- 
ache for large corporate enterprises which are 
publicly owned and whose ownership is widely 
orpora ions S p rea d than for the smaller ones. The reason for 
Justify Retention , . . . - . . . 

this is that many such large enterprises, in the 

main, have needs and are engaged in constant developments which 
seem to speak for themselves. The sudden demands of new markets 
for new equipment to produce the products for those markets, for 
buildings to house the manufacturing activities, the needs for im- 
provements to replace obsolete machinery, and for new or revised 
techniques are more self-evident than in the case of smaller enter- 

My experience is a somewhat limited one. It does encompass one 

company whose sales have grown in twelve years from approximately 

$20,000,000 to over $80,000,000. During that 

amp e row p er i d the dividend policy of the company has 

been to plow back into the business an average 

Dividend Retention . . r . rp, 1t £ 

of about 50 per cent or earnings. Ine results or 

that policy have been a very substantial growth in the assets of the 

company, its ability not only to supply broader markets in the United 

States, but to undertake to meet the interesting challenge of supply- 


ing certain markets throughout the world which were formerly sup- 
plied largely by the Germans. During the course of its development, 
the company has also obtained additional capital through debenture 
loans from insurance companies, the issue of common and preferred 
stocks through public offerings, and the sale, privately, of what would 
have been twelve years ago a very large amount, $9,000,000 of pre- 
ferred shares to one insurance company. 

Within the last ten years the developments of the scientists in the 
field of medicinal research have been such that one could not say 

from month to month what might be the de- „ 

_ , , .... Research Developments 

mands upon the business withm the next year. , - . . 

_, t , 1 11-1 • Increase Capital 

Plants have had to be built running into costs 

of millions of dollars which could not have pos- 
sibly been foreseen in the previous year. There is no indication in 
this particular field that that situation will not continue indefinitely 
and indeed it is for the welfare of mankind that it should continue. 
We would be false to our desire for progress if we did not seek accom- 
plishments which will require the investment and at least justify 
withholding from stockholders a substantial proportion of earnings, 
for reinvestment for their protection. 

The stockholders of today and the future, in this particular enter- 
prise, are far better off than they would have been if the company had 
paid out substantially all of its earnings and destroyed its position 
to utilize them to revitalize and expand. They are better off by the 
dividends they have received through earnings thus maintained and 
by resulting market appreciation of their holdings. For when you 
have a type of business in a field where new products are constantly 
being developed, and the success of which, by the nature of the busi- 
ness, depends upon development of effective new products, you have 
perhaps a different problem from, say, straight steel production or a 
canning operation. 

Now as to the reasonable attitude which it appears to me has been 

exercised by the Bureau of Internal Revenue. This is good because it 

is intelligent administration. But I am not so „, „ „. 

.. ,. , , . , Weapon for Planners 

easily comforted, because it seems to me that a 

weapon has been placed by Congress in the hands of our federal gov- 
ernment which could be used by planners of the socialistic type who 
seek to reconstitute our economy so as to destroy the ability of large 
corporate enterprises to provide for the demands of the future; and 
certainly it discourages, in my opinion, the growth of small enter- 


There is an article in December's Reader's Digest* where a small 
businessman describes his quarrel with Section 102 in which you may 
be interested. 

Through my interest in the administration of an estate, I am ac- 
quainted with the affairs of a medium-sized corporation whose stock 

is publicly held. It has four factories, two in one 
Prudent Management x - . . A ,. - , , 

state and two in another. An enlightened and 
Decisions Threatened . ,. , , , A .^ , 

revitalized management brought its business, 

which was in the doldrums, back to a very suc- 
cessful enterprise. The sales of that corporation increased tremendously 
during the years 1940 to 1947. About 20 per cent of the voting stock 
of the corporation which was a working control was in the hands of 
one person. There was a loud clamor from certain of the common 
stockholders for dividends. The dominant owner himself, being a 
self-made man of sympathetic considerations, was not averse to the 
declaration out of the substantial profits of a dividend on the com- 
mon stock, citing Section 102 as the first reason and his desire that 
the common stockholders have some immediate return out of the 
earnings as the other reason. Certain of the directors, who I think 
were also very competent businessmen, foresaw a very sharp break in 
the market for the company's products, and thought also that there 
was a period ahead of cash demands in order to permit reorganiza- 
tion and re-equipment of the different factories so as to achieve greater 
efficiency in operations necessary to meet competition as distinguished 
from sales. By a very close vote, a motion to declare a dividend on the 
common stock was defeated. The dividend, of course, would have 
meant very little to the dominant stockholder because he was in the 
topmost brackets. 

The foresight of the directors who opposed the declaration of a 
dividend proved to be correct for in the ensuing two years the profits 
fell off substantially. Although they were adequate to carry the oper- 
ating expenses of the business, interest on outstanding loans and on 
additional short-term loans necessary to carry inventory were such 
that, with a slowly reducing inventory, the corporation would have 
been faced with serious difficulties if it had not conserved cash rather 
than utilizing it for dividends. Fortunately, however, it had this un- 
expended cash, and the character of its management was such that 
the banks were willing to continue to advance it sufficient funds al- 
lowing it a period of time to work out its inventory and operational 

4 Carl A. Gray, "Why Does Uncle Sam Pick on Us?" Saturday Evening Post, 
(October 1, 1949). Condensed in Reader's Digest, LV (December, 1949), 130-34. 


problems. Therefore, an interesting question arises in my mind: Does 
that company, on account of not paying out dividends during the 
years when it had substantial earnings, face some day a tax assessment 
which might drive it into bankruptcy or virtual bankruptcy? 

Another example with which I am familiar is a charitable organ- 
ization which has had three different companies offered to it by the 

dominant stockholders, who have been lamely ... c . , 

° J Influences Sales of 

influenced by Section 102 to get out of the head- _ . 

1 ° Businesses to 

aches 01 management and let someone take them _ _ 

, ... Tax-Exempt 

over and pay them out on a capital gams basis _ . . 

-At t>u * t .u Organizations 
over a period or years. That, tor the reasons 

which the previous speaker, I think, brought out very successfully, 
seems to me to be a most unfortunate situation. We see men, who 
have built their businesses from small origins to highly successful 
enterprises, being forced by their judgment to divorce themselves 
from those enterprises and permit absentee management. 

It seems to me, in conclusion, that if Section 102 is unsound, every- 
thing should be done by the Tax Institute that is possible to bring 
home its unsoundness, because if it remains, it would become, to my 
mind, a very dangerous weapon in the hands of an unscrupulous gov- 
ernment if we are ever so unfortunate as to have one. 

Discussion of Statement by George Sibley 

Mr. George: Any questions for Mr. Sibley? 

Professor D. T. Smith: May I ask one, Mr. Chairman? In your own 
company, was your dividend policy influenced significantly by 102? 

Mr. Sibley: No. 

Professor D. T. Smith: I inferred that. 

Mr. George: In regard to the three companies that were offered 
to the charitable organization, you spoke of 102 as being the prin- 
cipal headache? 

Mr. Sibley: Yes. 

Mr. George: Any other questions? 

Mr. Ayers: Both in Mr. Cann's case and the cases of Mr. Sibley, 

isn't it true that estate tax problems might have „„ 

, , , . , , . , ^ . . . Effect of Estate Taxes 

had some substantial bearing? That is, is it 

possible to say that Section 102 was the sole controlling factor? 

Mr. Sibley: I didn't say it was the sole factor; I said it was the 
impelling factor. 

I don't think that the estate taxes were of such primary considera- 
tion because of the relative youth of the people involved. 


Mr. Ayers: That is a good answer; that is what I was driving at. 

Mr. Sibley: In all three cases the dominant owners were men in 
the prime of their lives. 

Mr. Turner: In his testimony before the Judiciary Committee, 
a Mr. Vandeveer, 5 who had an oil company in Ohio, coupled 102 
with the estate tax. As I understand it, that company sold out. I think 
of the two main men, one was 58 and the other was age 60. The point 
he raised was that 102 coupled with the estate tax just made it im- 
possible for them to see how they could pay their estate taxes in the 
case of either one of them. They were in such a high bracket for 
income tax purposes that even if dividends were distributed to avoid 

„ . . . , 102, they wouldn't have enough left after they 

Combined Effect of ' , ; r , , & . . ,. ! 

paid the federal tax to buy securities which 
102 and Estate ,,,.,. j » . 1 u t_ 

would be in their estates, and which could be 

used to pay estate taxes. Therefore, they would 

have to sacrifice the stock of the company in which they owned the 

stock, and the sale of it would practically wreck the company and 

they decided the thing to do was to sell out. They coupled the two. 

Mr. S. A. Smith: Well, their difficulty went a little farther back; 
they started farther back because they had plowed back all of their 
personal earnings into the business instead of getting outside capital 
and so they were building up their own personal estates. They plowed 
it right back into the business. 

Mr. Turner: That's right. 

Mr. S. A. Smith: So they had either one or the other and got 
caught either way. 

Mr. Turner: But he also pointed out that if they had distributed 
the earnings they would have been caught. 

Mr. S. A. Smith: Because that was the only investment they had. 

Mr. Kurzman: In those cases, Mr. Sibley, 
Sales of Businesses . . ~ , A , . , , 

where companies were offered to a charitable 
to Charitable r . . , „, 

trust, were any or those situations where there 

had been unusualy large earnings in one year? 

Mr. Sibley: One was. 

Mr. Kurzman: That brings up the situation that dominant stock- 
holders feel that these earnings must either be paid out or the com- 
panies must be liquidated or must be sold or they will suffer Section 

5W. W. Vandeveer, Hearings Before the Subcommittee on Study of Monopoly 
Power of the Committee of the Judiciary, U. S. House of Representatives, 81st 
Cong., 1st Sess., November, 1949. See also "Suicide of a Business," American Affairs, 
XI (October, 1949), 228-32. 


102. It seems to be a peculiar aftereffect of a boom such as the textile 
companies had that Mr. Cann was condemning because these people 
suddenly find they have to do something and they have to do it im- 

Mr. Cooper: Mr. Sibley, I don't quite understand myself in that 
situation you described how a sale after the earnings had been ac- 
cumulated will save them from 102. 

Mr. Sibley: Well, it has to go on year after year. 

Mr. Cooper: Then it is possible future earnings. 

Mr. Sibley: That is right. 

Mr. Kurzman: If a company which was subject to 102 were ad- 
vised of the situation at the end of the year — 

Mr. George: Within the year it doesn't make any difference. 

Mr. Kurzman: I meant within the year. 

Mr. Ayers: Or even immediately after the close of the year. 

Mr. George: This question I have in mind is clearly one which 
belongs to the policy committee, but I would just like to get your 
reply for their consideration. Do you think that 
this Congress should make any effort to lighten 
the burden of surtaxes, and have you any alter- 
native in mind for their consideration, without discussing it? 

Mr. Sibley: No, I haven't an alternative in mind sufficiently clearly 
to take up the time of the gentlemen here in view of what they may 
have to say. I have an alternative vaguely in mind. 

Mr. George: Well, I think that the suggestion that the whole tax 
system be overhauled is always a good thing. (Laughter) 

Mr. Sibley: It seems to me it is reaching a point in this country 
where it is going to have to be overhauled. Speaking right on that 
point, many companies are having trouble in re- 
taining executives under the pressure they must 
work under because of the little they have left 
after taxes. That is fatal to this country. Of course, if stockholders in 
publicly held companies don't get any increased dividends, they suffer 
a disadvantage against the wage earner, who receives constantly in- 
creasing rates of pay. 

Mr. George: Our next speaker is Mr. Rudick. May I suggest that 
we follow the rule that was agreed upon in the beginning that indi- 
cation be given of the function and type of business so that it will 
be available for the record. 

Mr. Rudick is a member of the New York law firm of Lord, Day 
& Lord. Mr. Rudick, may we hear from you. 


Statement by Harry J. Rudick 
Lord, Day & Lord, New York 

Mr. Rudick: What I propose to do is to take Professor William- 
son's memorandum and comment on his comments. 

He starts out with the charges against Section 102 and lists first the 
effect on dividend policy. My conclusion, necessarily based upon 
limited personal experience and on hearsay, is that while 102 has 
had some effect on forcing out the distribution of more earnings than 
would be justified by sound business policies, there is no conclusive 
proof that it has had a significant effect in that direction. 

As to the alleged bad effects, the first is inadequate working capital 

for a growing business or inflationary periods. Again speaking from 

N F' th d K 1 H P ersona l experience and hearsay, I don't know 

,*,... of an Y cases where the distribution of dividends, 

of Depletion , ; . , . n , , ' 

, _ . . to the extent that it has been influenced by 102, 

of Capital ■ ■ ; ' 

has seriously depleted working capital or 

amounts which are necessary for expansion. Mr. Cann and Mr. Sibley 

have given you examples where there have been those bad results, 

but I personally have no firsthand knowledge of any. 

Another alleged bad effect has been increased borrowing, but I 

suspect that the principal reason for this is not 102, but the fact that 

... . „ . the market for equity securities is depressed. We 

Alleged Borrowing . 

..... . nave a very low pnce-to-earnings ratio in the 

_ . _ . stock market and the directors of a corporation 

to Depressed Equity , . . , . \ 

would be foolish ordinarily, under existing con- 
ditions, to go out and sell stock when they can 
borrow at %i/ 2 to 3 per cent. If the market for equity securities im- 
proved and you could get better prices I think there would be less 
borrowing and more sales of equity securities. 

Another alleged bad effect is additional stock issues. I suppose what 
Professor Williamson means here is preferred stocks. What I said 
about borrowing would apply equally to preferred stock. Most pre- 
ferred stock issues now are essentially borrowing. They have sinking 
funds and they are in most respects similar to indebtedness. 

Another alleged bad effect is prevention of growth and expansion of 

D , . plant and equipment. I don't see why 102 should 

prevent growth and expansion of plant and 

equipment because if you do spend your money 

in expansion and growth, or increase of plant 

and equipment you are not subject to 102. It is only when you 


don't spend your money for those purposes that you might incur a 

As to retardation of the development and production of new prod- 
ucts and of other ventures, well, I think 102 mM m , „ 

t , , , T , . , , 102 Both Promotes and 

works both ways there. I think that 102 has m . m , 

, . . Retards Development 

caused many companies to go into new ventures , . , „ . 

j * j i j 1- t 1 of New Products 

and to develop new products, whereas if there 

weren't any 102 they might not do it. 

Another alleged bad effect is prevention of adequate reserves to 

meet vicissitudes. I think there is some justification for that charge, 

but, as I said at the beginning, I don't think kl , , 

„ . . . .,, . , May be Important to 

that over-all it is very significant; it may be ter- ' . . „ 

.. . . , . , _ Particular Companies 

nbly important to particular companies, as Mr. „ ., , .. 

^ j »* «.t 1 1 • 1 1 But Not for Economy 
Cann and Mr. Sibley have pointed out, but 

taking the economy at large I don't think it has any significant effect. 

Now, Professor Williamson also listed some effects other than divi- 
dend policies. He referred to resort to debt rather than equity financ- 
ing but I think I have already commented on that. He also refers 
to the issue of stock dividends. Personally, I don't see how that could 
have any bad effect. 

Stimulation of mergers: Mr. Cann commented on that and I think 

there is a good deal of truth to what he says — _ .. , . , ., 
... . , , , Stimulation of Mergers 

that is, that 102 has stimulated mergers and 

sales of businesses whether to competitors or 

to other companies or even to charitable organizations. I think there 

is considerable justification for that conclusion. 

Another asserted effect is the uneconomic or _ 

. _ . , Some Uneconomic or 

excessive purchases 01 plant and equipment. . . 

There has been some of that, as Mr. Cann's u , 

-, 1 ^ T 1 , 1 • * 1 Investments 

example shows. But again, I don t think that 

over-all it has been sufficiently important. 

Window-dressing devices: Mr. Austin has com- .... , 

. . . *i .. . , . , Window-Dressing 

mented on them. I think they were resorted to _ . _ . 

• i t i 1 r , ^ , , r™ Devices Being 

considerably at the end of 46 and 47. They 

have gradually been reduced and are gradually 


Now, one effect which is not mentioned in Professor Williamson's 

memo is that 102, I think, causes many corpora- „. , 

1 r 1 • 1 mi. * 1 Tendency to Keep 

tions to keep funds uninvested. They keep large m .... 

. . . r , , , , , Funds Uninvested 

cash balances or government bond balances be- 
cause they know that if they invest in securities of unrelated businesses 


they imperil their position under 102; so I think there is a consider- 
able tendency to keep funds uninvested. 

One charge against the section which is not mentioned is that it is 
ineffective in producing the results aimed at. There are many cases — I 

think all of us could cite some — in which the 

Section Ineffective r . , ,, 

owners of the corporation know very well 

that they are vulnerable under 102 but they 

know that the penalty for being vulnerable under 102 is less than the 

cost of distributing the money, as a dividend, so they don't do it. 

Mr. George: You think that is pretty widespread? 

Mr. Rudick: Well, I don't know whether "widespread" is the right 
term to use. Put it this way: it is not uncommon among closely held 

Now, admitting all of the bad effects of 102 — and there are bad 

effects of 102 — I don't see that you can do without it. That is not to 

„ ^ , say that it can't be improved, but I don't think 
Improve, But Don t ,. «. . , , T 1 • * 1 1 j 

, „ . you can dispose of it altogether. I think the bad 

Repeal Section ' ri . . ,, ,-,, 

effects of repealing it completely would be worse 

than the bad effects of the present situation, as bad as it is. 

Next, as to the comments made at the end of Professor William- 
son's memorandum. First, about the necessity of immediate reinvest- 
ment of the profits. Mr. Austin touched on that and there have been 

a few cases which have indicated that the Tax 
Reinvestment of _ , . . . .. 

Court requires a relatively immediate investment 
Profits . , L . . _ , , , . , 

of surplus earnings, but I don t think you can 

rest your conclusions on the results of a few cases, because if there 
is one thing you can get out of a study of the 102 cases, it is that you 
can't rely on precedents set out in them. 

I think the credibility of witnesses is extremely important in those 

cases, and if the Tax Court were persuaded that the owners were really 

withholding distribution for future purposes 

1 iry 01 w hich were real, in their belief, the decision 

would probably be in their favor. It is largely in 

cases where the Tax Court — whether it said so or not — didn't believe 

that they were holding back the earnings for legitimate purposes that 

it decided against them. 

The amount of ignorance with respect to the application of Section 
102 is, I think, an important factor. Mr. Cann 
gnorance touched on that and it is brought out very clear- 

Respecting 102 ly . n testimony be£ore the Small Business Com- 
mittee which is mentioned in Professor Williamson's memoran- 


dum. Perhaps, we have to educate the business public to the real 
meaning of 102 and if we did, perhaps, it wouldn't be such a bugaboo 
to them. 

I think most of these other comments have been covered by the 
previous speakers and I am in general agreement with most of what 
they have said. 

One thing that Mr. Austin said, though, I am not in agreement 

with, and that is his striving for certainty. We all like certainty, but 

when it comes to the field of tax avoidance I 
... , , . , Certainty Impossible 

think you can t have certainty, because there is 

one thing you want to do and that is deter tax avoidance and you 

can't write any tax statute which will close all of the loopholes. So it 

is better to have an area of uncertainty because I think that has some 

deterring effect on attempts to avoid tax and you would have much 

more frequent attempts if you didn't have that area of uncertainty. 

Discussion of Statement by Harry J. Rudick 

Mr. S. A. Smith: It is much better for the lawyers too. 

Mr. Rudick: Yes, it is much better for the lawyers too, I grant you 
that. But on this question of avoidance one thing that most of us 
are prone to forget is that when one group of taxpayers doesn't pay 
all the taxes it should all of the other taxpayers in the country have 
to pay more than they would. 

Mr. George: Of course, you are raising a most embarrassing ques- 
tion; you are implying knowledge of what equitable tax distribution 
should be. 

Mr. Rudick: I don't suppose I know any more about that than 
anyone else, but I do think there are improvements which most people 
would agree upon. 

Mr. George: Yes, I am sure of it. 

Mr. Rudick: As I said before, I think we have to have 102. We 

can't do without it or some substitute for it, because as long as the 

individual rates are substantially hisrher than the 

. r , , , , High Individual Rates 

corporate rates, if you don t have some mechan- " 

, . , .,, t - r . Make 102 Necessary 

ism which will prevent the use of a corporation 

as a refuge from surtax you will have so much avoidance that the 

effects will be far more serious than under the present system. 

Mr. George: And as in the previous case a general reform of the 

Mr. Rudick: Well, I am all for reform of the taxes. It depends 
upon what kind of reform you have whether you can do away with 


102. I think if you allowed deduction for dividends paid, for example, 
that means an undistributed profits tax which is anathema to most 

people, but if you allowed that I think, perhaps, 
Deduction of Dividends r l . , , ' . , . £ „ , x 

you could do away with 102, 11 you allowed a 
Means Undistributed ' , . r ,. ., , . , ^u 

deduction lor dividends paid. There was a ter- 
rific hue and cry against the undistributed prof- 
its tax we had, but I don't think there is any proof it had any serious 
adverse effects upon the economy. When we had that tax, even if a 
company distributed only 30 per cent of its income its aggregate tax 
on its income was only 25 per cent and they are now paying 38 per 
cent and not kicking. 

Mr. Turner: Would you be in favor of 102 
Avoidance of Double .. . ,. r . j c 1 j--jjt_ 

_ _. , ^ , being continued if instead of the dividends be- 
Tax Through Credit ° . _ .. . .. , , . ,. ., , 

me deducted credit is allowed the individual up 
for Dividends ° . . . ,. . , , . 

to a certain rate on their dividends? 

Mr. Rudick: I think the need for it would be very much less. You 
mean if you avoid double tax? 

Mr. Turner: A credit to the individual would be a step toward 
the avoidance of double tax, as they do in Canada and as Senator 
George is proposing. 

Mr. Rudick: I am all for that and I think that if you did that the 
need for 102 would be very much less, but I still think you would have 
to have 102 in some form or other. That is not to say it can't be 
improved. I think it can be improved very materially. But I still think 
you have to have it. 

Mr. Turner: If you had complete credit for dividends then there 
would be no point in accumulating profits for the purpose of later 
distribution. H 

Mr. Sibley: That's right. 

Mr. Turner: And the only reason you would accumulate profits 
would be for business purposes. 

Mr. Dixon: But look at the unfortunate position in which it puts 
a concern that needs to withhold all of its profits for its business 

Mr. George: You mean the undistributed profits tax? 

Mr. Dixon: Yes. It becomes a penalty then on an organization such 
as Mr. Sibley is connected with and it is very, very inequitable and 
very damaging. 

Mr. George: I would like to make two points about that. I am 
sure we wouldn't get very far by discussing a revival of the undis- 
tributed profits tax, it being an entirely different kind of animal and 


in the second place we have drifted inevitably into the question of 

policy. I think that that is permissible and probably useful to the 

point of identifying ideas but it is certainly beyond our scope to 

discuss it. 

Mr. Austin: I would like to make a couple of comments, by way 

of clarification. I was speaking about the uncertainty of many areas 

in the tax field today. I wasn't thinking of tax avoidance problems. I 

don't hold any brief for laying down a set of predictable rules for 

tax avoiders, but there are a great number of ,.„, 

... «. 1 1 . -. ■, • Widespread Uncertainty 

situations in which perfectly legitimate business . _ . 

rr 1 . -i • i m Tax Laws 

transactions are affected with uncertainty, prob- 
ably because of implications that arise out of tax avoidance cases, and 
probably just on account of the confusion that has grown up. I don't 
think I can multiply them too much. I know we were talking about 
some of them the other night as to when debts will be debts and 
when they will be treated as a capital. The whole thing is a problem 
and when we were through with the discussion I am sure nobody was 
any wiser than when he started. 

That is an illustration and a very poor one, but there are a number 
of other legitimate situations of that nature. 

Secondly, if a few court decisions create a general impression among 

businessmen and practitioners that that is the rule by which you have 

to go, the effect is just as real as if the doctrine were perfectly valid; 

and, of course, you get a case like this World 

„ ■ . t . ~ 1 -. ■, Effect of Court 

Publishing Company case where the court made _ . . 

r ,. , 1 j r • Decisions 

a finding that there was a need for an extensive 

rehabilitation program, but said that because the war made its con- 
summation a thing for the indefinite future that they had to pay out 
their earnings now, especially as they would probably make that much 
in the intervening period. You get cases of that kind regardless of the 
validity of the conclusion of it, but the effects are clear enough in 
the widespread impression it creates. 

Mr. George: This question of immediacy keeps cropping up and 
I expect it will continue to do so. I always thought, personally, that 

the problem that faces the officials that have to ... 

r Immediacy 

do something about it and must set up some 

kind of standards of evidence was one of the nasty points in the 

administration of the law. 

If anybody has any thoughts about that in the course of his regular 
discussion I think it would be useful to bring them in. 

Now I am going to call on Mr. Clarence L. Turner, an accountant. 


Statement by Clarence L. Turner 

Turner, Crook & Zebley, Philadelphia 

Mr. Turner: I think the greatest fault with and the harmful 
effects arising under Section 102 lie with the wording of the section 
in that the burden of proof is on the taxpayer and the tax imposed 

is assessed on the entire net income, undistrib- 
Fault Arises from _ _- , , . ,. , t . ^ « . 

uted. If we go back into a little history on this 
Burden of Proof . _ ? . . . , . ,, , 

section we find that prior to 34 practically the 

only cases involving this section were with respect to closely held in- 
vestment or security companies and, of course, these companies are 
now covered by the present holding company section of the Act. The 
National Grocery Company case was the first really business case to 
get into the courts. After the undistributed profits tax passed out of 
the picture, I think is when the real apprehension began to grow in 
the minds of business and since that time I don't think there is any 
doubt but that Section 102 has influenced dividend distributions and 
continues to do so. 

Speaking about particular cases, I have one in mind, a textile con- 
cern. The voting control is entirely with the family, a husband, wife, 
and two boys who work in the business. Let's just take that situation. 
In 1929 it had a substantial surplus; it had had substantial earnings 
during the twenties. By 1936 and 1937 it had a substantial deficit. 
Then came the war years during which the profits were not large 
because of the inability to get wool in sufficient quantities to really 
do any volume of business. And then it took some government work 
which was unprofitable. With the pent-up lack of supply because of 
the war and the resulting backlog of orders after the war, the profits 
in '46, '47 and '48 were substantial and will be substantial in '49. 

The question came up and was discussed with us as to what should 

be distributed in the way of dividends. It so happens that its cash is 

in excess of what it had been prior to this growth, but the receivables 

and inventories also increased and a substantial 

102 Influenced ^^ q£ ^ p rofits ^ not only £or the curren t year 

Dividend Declarations ^ ^ ^ ^^ were ^ up {n inventories 

which were, of course, at inflated prices. Some distributions had been 
made. Whether too much had been distributed we do not know. The 
way it was resolved was that there was calculated just where the line 
of cleavage would be as to the taxes that would be paid by the indi- 
viduals on receipt of dividends, compared with any taxes the com- 
pany would pay if Section 102 were applied, if it were held that suf- 


ficient dividends had not been paid. That really controlled the amount 
of the dividends. I question whether the company probably did not 
distribute too much in view of its prior experience, because there 
are going to be some loss-years; a corporation of this type does not 
have all profit-years. 

The plant has been working three shifts which, of course, piled up 
its profits in these years. The company is now going into the replacing 

of old equipment in order to be able to retain 

r . , r , . ,. .. . TAT , , Capital Investments 

profits instead 01 making distributions. Whether 
*.. . , 1 j • • r • • Increased 

this is gooa or bad, in view of its past experi- 
ence, one cannot tell. No one can forecast how many more good years 
it is going to have before it again has years with losses. But certainly 
102 has definitely been responsible for these actions, both from the 
standpoint of declaring dividends and also from the standpoint of 
investing in plant and equipment. 

I have another company in mind which is also a family, two-family 
concern. I think there are about twelve or fifteen stockholders but 
they are composed of two families. Originally there were two owners 
and it is the younger generation that now holds the stock. It is a 
textile concern, in this way, that it furnishes supplies to the textile 
trade and it is in the same position. It had substantial earnings in the 
twenties, a surplus after the twenties, and then during the thirties 
piled up a substantial deficit. The question came up there as to what 

should be distributed. They knew that their 

, , , , - . . , , Excessive Dividends 

plant was old and that sometime they would 

have to give some thought to spending some money replacing it, but 
they had no definite plans, and the question of whether there should 
be something definite in the nature of commitments was also raised. 
Here we feel that probably there was too much distributed. There 
was not distributed anything like 70 per cent but even so, when there 
is considered the age of the plant and the amount of money that 
would have to be invested when prices are right, that is, when they 
feel the company could afford to make the expenditure, then it is a 
question of whether too much may have been distributed. There cer- 
tainly would not have been as much distributed as there was had it 
not been for Section 102. 

Another illustration: the other day the president of a company 
asked me to come up to the plant. He took me over a large area of 
land it had just bought, and he said, "I want to get out of that 
Section 102 and I thought I would put a building here, a building 


there, and a building there." I said, "What are you going to do with 
them?" He said, "I haven't enough room to house the equipment." 
(The company went into a separate line of business and it is going to 
use the buildings to house the equipment.) He said, "I don't have much 
of it on paper, all of this is in my mind, but what sort of a fix am I 
going to be in?" The company will end the year 
pansion pee e p ^.^ j ar g e p ro fits, the largest it ever had in its 
history, and it probably will never have another year anything like it. 
He further said, "I want to use this money to do this work because I 
won't have the money in future years." There came up the question 
of whether he should make actual commitments. I told him he should 
make actual commitments in so far as he felt safe in making the com- 
mitments, but I told him I would not make any commitments that, 
from a business standpoint, were not sound. 

Then I told him that he should get his plan down on paper and 
then obtain estimates of what the probable costs would be, and to 
the extent that he had actual commitments he should set up a liabil- 
ity. Where he did not have any commitments, he could set up a reserve 
out of surplus to the extent of the balance of the estimate costs. 

I do not know whether that will hold or not; it depends. I think 
that subsequent events will show that the estimates, as made, were 
proper, but when it comes to having to say that the company had 
actual commitments or a definite amount that at the time could be 
said was going to be actually expended, it is another matter. This 
action is one entirely dictated by Section 102. In other words, these 
things that are being done now by way of expansion otherwise would 
probably have been done over a period of years. Having these large 
earnings this year and feeling that the company will not have any 
like earnings for several years to come, is really influencing the making 
of these expenditures now and during the next year. 

Another illustration is of a textile concern which paid out more 
than we advised it to pay out. The company is in such financial posi- 
tion that I had to caution them and I do not know exactly what sort 

of a financial position it is going to be in. It 
Excessive Dividends ^ ^ ^^ money frQm ^ bank and had 

to borrow a fairly good-sized amount for the size of the business. If 
it had retained its earnings it would not have had to borrow money, 
that is, if it had not paid out too much. As I said, the directors were 
very much afraid of the effects of 102 and paid out a great deal more 
than we would have advised them to pay out. 
Another point that I think must be considered, where a concern 


takes its earnings and invests them in physical assets, is whether or 
not it would be taking such action only for the purpose of avoiding 
the distribution of earnings and therefore run the risk of being taxed 
under Section 102. 

I think, as has been said by previous speakers, although it is pretty 
difficult to measure, the impact of all of these individual and different 
cases must have some effect on the economy as a whole. There cannot 
help being some effect and I think that has been 
brought out in the testimony that is being given 

before the House Judiciary Committee investigating monopoly. Sec- 
tion 102 and other provisions of our Internal Revenue Code tend to 
increase monopoly and I think it hinders small businesses from grow- 
ing and makes the bigger ones larger. 

I do not know whether we are going to be able to come up with 
an answer that can be stated in terms definite enough or not, but 
certainly my experience has been that something ought to be done 
about 102. 

Discussion of Statement by Clarence L. Turner 

Mr. George: Well, you raised quite a number of points in your 
examples. Your first two examples dealt with unstable industries, the 
next was of possibly forced or uneconomic expansion and proof of 
intention, and the fourth was excessive distribution. 

Any questions for Mr. Turner? 

Professor D. T. Smith: I am a little puzzled by his reference to the 
proposition that its general effects were to stop small business from 
growing and make the big ones bigger. On stopping small businesses 
from growing, do you mean stopping small businesses from getting 
under way in the first instance? 

Mr. Turner: I mean this: You take a lot of small businessmen 
who read about Section 102; they read about the 70 per cent distribu- 
tion and if they read the regulations they will find that even if a 
corporation distributes 70 per cent it still may 

be subiect to 102. It depends on the kind of _ „ „ . 

J r Small Business 

business. And they get panicky and pay out all 

of their earnings in dividends. If it is a small business just starting or 

not many years old, the individuals are not penalized too greatly by 

the distributions, but in many cases the distributions are made when 

they ought not to be made and probably would not be made if it 

were not for Section 102. As a result, such concerns are not able to 

retain their earnings and plow them back into the business. 


Professor D. T. Smith: In other words, were it not for the incor- 
rect interpretation of 102 by the businessmen we might have a per- 
fectly legitimate case for retention. 

Mr. Sibley: I do not think that is so all of the way. 

Professor D. T. Smith: Or is it a cyclical proposition? There is no 
reason why a small business cannot have as good or even a better 
case for retention under 102 as large business. 

Mr. Turner: I think that is true except for this: a small business 
might be making a comfortable profit but not large enough to do 
anything with, but it feels as though it has to distribute its profit. 

Mr. Sibley: Instead of accumulating? 

Mr. Turner: Instead of accumulating. 

Mr. Cann: Mr. George, part of that difficulty comes out of taking 

one particular year, for example, and applying 

., , , _ ' . , , 102. What ought to be done in fairness is to 
Should Be Considered _ , , ° . _. 

look at the years immediately preceding and the 

subsequent years. You generally can look at years subsequent because 

the Treasury is from one to two years behind the current tax return. 

Mr. George: Would you extend that to a provision to carry it 
over a long period of years merely for the consideration of the com- 

Mr. Cann: I think language can be inserted in 102 to provide 
that such a test should be made and I think it should be done. 

Mr. George: May I ask this question, Mr. Turner? You had two 
kinds of situations, one in which they paid more than they should, 
and the other in which they sought ways in which to invest the money 
in order to avoid the appearance of retention for tax avoidance pur- 
poses. I assume that in all of your cases the stockholders are in the 
high brackets. 

Mr. Turner: Not in all cases. In one or two cases they were in 
high brackets in their minds but they were not high brackets as we, 
as practitioners, think of them. 

Mr. George: Have you any opinion or guess as to on which side 
of the line these cases fell more heavily, as to those who paid out too 
much and those who went into doubtful expansion? 

Mr. Turner: I would say those who went into doubtful expansion. 

My thought is that their immediate expansion would have been more 

_ , , , „ . moderate and spread over a greater period, in 
Doubtful Expansion r or' 

which case they probably would have withheld 

some of the earnings waiting for the possibility of a break in prices. 


Mr. Austin: That is an uneconomic expenditure. 

Mr. Turner: Yes, an uneconomic expenditure. 

Mr. George: It is sometimes a premature expenditure as I see it. 

Mr. Kurzman: Maurice, doesn't that comment presume that if 
they had paid it out in dividends and the government took it in 
taxes it would have been expended more economically or soundly? 
(Laughter) I think you also have to, at least, consider the possibility 
that building a plant in 1946 was more economical than building it 

Mr. George: Yes, that enters into it. 

This question I'm raising is the question of fear, and how much 

importance ought to be attached to it, as distinguished from fact. I 

asked a group before lunch to what extent it was possible to explain 

corporate action in terms of those people who ^ 

Question of Fear 
had a full and true understanding of where they 

stood under the law, and those who are acting, more or less, out of 

apprehension. And one of the answers I got was, well the answer to 

that is easy, the sophisticated know pretty well where they stand, and 

the unsophisticated don't, and they are likely to act blindly. 

Well, it seemed to me that answer itself was fairly important, and 
I was wondering if it would be worth while, as you go around the 
table, for you to find some place in your discussions for a com- 
ment on the extent to which you think that your people are acting 
primarily on a fairly sound knowledge of their obligations and haz- 
ards under the law, and the extent to which, because of mere fear 
and lack of understanding of administrative standards they fork out 
money they otherwise would not. 

Mr. Rudick: Perhaps you ought to modify that a bit to apply it 
to cases where the fear is of the tax imposed by the government, pri- 
marily on stockholders. 

Mr. George: Well, we discussed that too, and as long as it is out 
in the open, let's leave it there. My own reaction to that was, it has 
appeared spontaneously in the comments of one or two of those who 
have spoken thus far. I thought personally it might be better to let 
it happen that way. If it was important to a man he was free to say 
so. If it wasn't, he wouldn't, and rather than put ideas into the 
minds of the witnesses, I was not going to ask for any special com- 
ment, but I'm open to suggestions. After all, we're feeling our way. 

Mr. Cooper. 


Statement by Walter Cooper 
Peat Marwick Mitchell & Company, New York 

Mr. Cooper: Well, I'd like to preface what I have to say by bring- 
ing into the record, for the benefit of the policy panel, one thought. 
That is that we seem to be following over here, to some extent along 
_ . . . _ .. political lines, the British, at least so far as the 

B " tlsh P °" Cy welfare state and some socialistic schemes are 

concerned, and it might be well to note that the British have aban- 
doned completely this idea of forcing distribution of earnings. They 
have swung around the other way. They have eliminated their 102 
situation, or what was the equivalent, which we actually copied back 
in 1913. 

They now impose a tax on distributed earnings, so that every time 

a dollar is paid out in dividends the company has to pay thirty cents 

in tax to the British government, or the equivalent in sterling. It 

might be well to get that before the policy panel, because we had 

some discussion before about this question of tax avoidance, and 

whether it was desirable to force the distribution of earnings — which 

102 is intended to accomplish. Perhaps the whole idea is no longer 

desirable in view of what we face ahead, which is just what Britain 

is concerned about, namely, trying to conserve the capital in their 

corporations, so that they will have it available 
Conservation of „ L . . . 

_, . , for war production and improvement in pro- 

Capital , . / . ,,.,,, , , . 

ducmg facilities (which they haven t done in 

the past); and likewise the second purpose is to avoid that money 

getting into the hands of the public for the purpose of expenditures 

for things already scarce and which would only tend to drive prices 

up more, and continue the spiral of labor's demand for higher wages, 

and so on. 

I just want to get that in the record at the start, because I think 
it might be important for the policy panel to have that idea in mind 
when they are considering various facts. 

Mr. George: Apropos of that, everyone realizes, I suppose, that 
the practice differs all over the world. Different nations get different 
notions about the function of profits and on the relative importance 
of stimulating consumption and investment. Something depends, no 
doubt, on their dissimilar basic conditions, but I always suspected that 
the differences were more in philosophy than in conditions. Different 
conceptions of equity also, of course, have some bearing. 

My recollection is that in the United Kingdom, where closely held 


companies failed to distribute "adequately," a super-tax correspond- 
ing to the amount for which he would have been liable with complete 
distribution, is laid on each stockholder; or failing payment, on the 
company itself. In Australia, the extra tax is assessed directly against 
the companies. Before the war, at least, the earnings of Dutch corpora- 
tions were taxed if distributed and exempted if retained. Some coun- 
tries tax both dispersed and retained earnings. One of them, Belgium, 
bears down heavily on retentions. I understand . 6 

that Sweden has in general relaxed or discon- 
tinued its previous practice of taxing retentions; and also permits 

6 Editorial Note: Tax policy with respect to retention of corporate profits has 
been liberalized in recent years in Australia, Canada, and Great Britain. As a result 
of the interest shown by the panel in foreign developments, the editor has secured 
from Tax Institute members in these countries the following brief statements con- 
cerning these developments. From the Taxation Institute of Australia, Circular No. 
185, 31st October, 1950: 

Apart from the concessions associated with the substitution of deductions for rebates, the 
most important concession proposed in the Bill [became law in 1950] related to the tax payable 
by private companies on their undistributed profits. In 1948 the law was amended to enable such 
companies to retain specified percentages of profits free from undistributed profits tax, so that 
the tax payable by a private company and its shareholders would approximate the amount of 
tax that partners in a comparable partnership would pay. 

Experience had shown those percentages to be inadequate in the light of changing condi- 
tions, and the Government accordingly proposed to increase the tax-free amounts. On the first 
£1,000 of a private company's distributable income, the proportion free from undistributed 
profits tax would be increased from 30% to 50%. At the higher levels the tax-free percentages 
would be increased to a lesser extent. If, for example, the distributable income of a private 
company was £10,000, the amount retainable free from undistributed .profits tax would be 
£2,750, as compared with £2,000 under the present law. The annual cost to revenue of this 
amendment would be about £1,000,000. 

Quotation from letter of Dr. A. K. Eaton, Assistant Deputy Minister, Department 
of Finance, Canada, to editor, June 20, 1950: 

I said I would attempt to tell you what we have done recently in Canada regarding the 
treatment of earned surpluses of corporations. It is quite a long story but I shall do my best 
to condense it. In Section 9 of our law as it stood prior to the recent amendments you will 
find the general treatment of undistributed income. Upon the winding up of a corporation this 
undistributed income is deemed to have been received as a dividend. You will see at once the 
problem here for small businesses where, upon the death of the chief shareholder, a large 
amount of succession duties might have to be paid. Under high income tax rates this provision 
could easily bankrupt an estate. It was found that the chief shareholder was resorting to the 
device of selling his shares to another company, usually at a heavy discount for the sake of 
getting his monies worth out in the form of untaxed capital gains. The purchasing company 
could reimburse itself by declaring a dividend out of the surplus of the acquired company. 
Dividends from one corporation to another have been tax free without limit in Canada. 

Look now at subsection 6 of Section 9 and you will see the authority for the Minister of 
National Revenue to deal with unreasonable accumulations of surplus. This section has been in 
the law for years but until recently has never been used to any extent. Recently it has been 
used in a few cases where the Department had information regarding a deal of the sort men- 
tioned above which was being negotiated. The Department then stepped in and deemed the sur- 
plus to have been distributed and that broke up the deal, although it was rather tough on the 

The above represents the background of the law as it was at the commencement of 1950. 
Bill 177 introduces a new system. On page 24 you will find provision for the payment of a 
15 per cent tax by private companies (75 or less shareholders). They can clean up past accu- 
mulations in one lump. Future accumulations are eligible to the extent that it pays out divi- 
dends. This is what we call a matching system. A dollar paid out makes a dollar retained eli- 
gible for the flat rate 15 per cent tax. The system now is that if the company pays 15 per cent 
tax on its undistributed income on hand, then upon winding up there is no further tax to be 


corporations to build up tax-free funds on the condition that they 
will spend them for purposes and at times stimulated by the govern- 
ment. Denmark did something like this too. Other countries are re- 
ported to have kept their special tax on retentions low and to have 
remitted it in case of subsequent disbursement. 

Mr. Cooper: Now getting back to our basic problem, my own 
feeling has been that there has been a lot more talk — too much talk — 

paid by the shareholder on this surplus. The power of the Minister to declare a surplus to be 
unreasonably high has been dropped. 

In the past dividends have been allowed to pass from corporation to corporation without 
tax. There is now a limitation on this. In brief, the provision is that where in the future one 
corporation acquires control of another, dividends received by the controlling company are tax 
free in its hands only to the extent of the earnings (after tax) of the controlled company fol- 
lowing the date of acquisition of control. This prevents the sort of deal which I mentioned 
above whereby a corporation could, by controlling interest in another corporation, declare itself 
a dividend of the surplus and pay for the shares which the shareholder of the first company 
was willing to sell at a bargain because of the potential income tax liability attaching to the 
large earned surplus. Incidentally, I might mention that these companies in respect of which 
control is acquired in the future automatically become eligible for the 15 per cent tax on their 
surplus, so that if the controlling company wishes to move the surplus it can do so after pay- 
ing the 15 per cent tax. 

See also "Some Aspects of Recent Corporation Income Tax Legislation in Can- 
ada," by Dr. J. R. Petrie, Director of Research, Canadian Tax Foundation, Tax 
Policy, XVII (September-October, 1950), 10-15. 

The following quotations from The Profits Tax Simplified (January, 1950) by 
Arthur Rez, British accountant, give the current status of the British tax procedure 
with respect to undistributed profits: 

The Profits Tax, under its original description of National Defence Contribution, wa9 
brought into being in 1937 in anticipation of war. During the war itself, however, this impost 
surrendered its important position to the more onerous Excess Profits Tax; but with the termi- 
nation of hostilities and the abolition of the E.P.T., the Profits Tax has been restored to its 
former eminence in the fiscal framework of the United Kingdom. 

The National Defense Contribution was introduced just over two years before the out- 
break of the war for the purpose of supplementing the revenue produced by the Income Tax. 

. . . Like other "temporary" taxes, it now appears to have become a permanent pillar in 
the fiscal structure of the country, for in 1942, when the war was at its height, the N.D.C. 
was renewed for an indefinite period. (Page 5.) 

With the disappearance of the onerous E.P.T., the rate of the Profits Tax was raised to. 
12y 2 % from the 1st January, 1947. In order to ease the inflationary situation, an attempt was 
made to discourage the payment of large dividends by according relief of 7}4% in respect of 
undistributed profits. The Profits Tax then ceased to apply to individuals trading solely or in 
partnership, since the entire profits of such persons, whether drawn or not, are subject to 
sur-tax. However, under the Finance Act, 1949, certain insurance underwriters may, neverthe- 
less, be liable to the Profits Tax. 

The discrimination between distributed and undistributed profits in favour of the latter is 
a reversal of previous fiscal policy. The contradictory aims of the Profits Tax and S.21, F.A., 
1922, which subjects undistributed profits of certain companies to sur-tax, has, therefore, led 
the Chancellor of the Exchequer to state: "It is not the practice in present circumstances to 
take action against a trading company under Section 21 in a bona fide case where the rate of 
dividend is the same as that which was accepted by the Special Commissioners as reasonable in 
previous periods, even though the company's profits may have increased". 

Before the year 1947 could come to its close, the surprisingly rapid exhaustion of the 
American loan resulted in a second Budget, which doubled the Profits Tax to 25% and the 
relief to 15% with retrospective effect to the 1st January, 1947. Again, towards the close of 
1949, devaluation of sterling was accompanied by a further increase in the rate to 30% and 
the relief to 20%, these being effective from the 1st October, 1949. 

The original N.D.C. was a comparatively simple tax to compute. The Profits Tax can 
hardly claim to possess the same virtue, for the provisions relating to undistributed profits, as 
well as multifarious changes in taxation law in recent years, have added considerably to its 
complexities. (Page 6.) 


about 102 than it really warrants, and that has really created in the 
minds of many businessmen a fear that really shouldn't exist. It has 

likewise created, I think, in the minds of some 

. , , , Divergence Between 

revenue agents, an idea about the circumstances „ , „ 

Bureau and Revenue 
under which the tax should be imposed, which . ... 

-r -i , i -,- -, -r, . *.* , . Agent Attitudes 

I don t believe the Bureau in Washington ac- 
tually, at higher policy levels, supports. That doesn't help a tax- 
payer when he has to fight with his revenue agent, but nevertheless, 
that is a factor. 

My own approach — we've had quite a bit of it in the last few 
years — my own approach most of the time when our clients have 

come in to talk about 102, is first ask them _ ., , . . , 
1 1 1 »titi i ^ a Clarifying Attitude 

bluntly: What are you tryinar to do? Are you 

r iiii 1 or Taxpayer 

trying to save taxes for your shareholders, or do 

you really need the money?" It is surprising how often, when you put 

it to them that way, it smokes out the real story, and they start to 

come out fully with all the reasons why they shouldn't distribute. 

You will get a few cases here and there where they say that "If we 
distribute the earnings there will be nothing left for the stockholders 
after taxes. We don't want to do that. What else can we do?" You'll 
get both kinds of cases, but it is surprising how many of them will just 
completely disappear and the fears of the management will be allayed 
the moment they really have to sit down and 
show what they need the money for. Also, as 

very often happens when you look at the balance sheet, you will find 
that they have made big profits, but there's not so much of them in 
the bank available for dividends or other things, and that the profit 
exists, in very many cases, in the form of increased inventories, not 
necessarily quantity but just dollar values, and sometimes in plant 

I have had a number of cases where there are things that the tax- 
payers have to do, but haven't done yet, and which, for one reason 
or another, may be deferred. Sometimes it is a matter of waiting for 
costs to come down. Sometimes they can't do it 
because of material shortages or production re- 
quirements. I know of one case where there 
were many things required, but the company just couldn't shut down. 
It was operating three shifts a day. The management couldn't stop 
and do a lot of things that they wanted badly to do. 

When we get those situations, we face the necessity of building up 
the record to show what was intended and support the position, so 


that if a question does arise later it can be shown that the explanation 
is not a matter of afterthought, because we have at least some indica- 
tion recorded at the time of what was contemplated. 

In a few cases we run into the actual factual situation where sub- 
stantial earnings have been realized. Let us say in the normal course 
of operations there is perhaps no reason to retain that money in that 

particular operation or business, but from the 
Stockholders' Desire r ., ,, -.r- ^u 

stockholders point of view the question is 

"What am I going to do? If I distribute it I 
have nothing left after taxes, or whatever little I do have left I don't 
want to spend, so I would take what is left and invest it in some other 

So the next question is — why doesn't his corporation use its earn- 
ings and go ahead and make the investment 

directly? That has undoubtedly, in some in- 
New Products , , . . ^ ^, cl ii 
stances, led to expansion into other nelds. 

Whether they are wise or not, nobody can say yet. Some of them 

probably will be. 

I know, for example, one case of a vacuum cleaner that is on the 
market that wouldn't have been on the market if it hadn't been for 
102. It is a form of business which has just a minor relationship to the 
operation the corporation had, because it was almost wholly in war 
production operations, so it sought some other field. 

There are others like that, for the moment not successful. I don't 
know whether they will continue that way, of course. Nevertheless, 
Section 102 has made available during the past few years a vacuum 
cleaner that wouldn't have been available otherwise, for people who 
really needed vacuum cleaners. 

But, as I say, not only has Section 102 created a fear that should 
not exist — but has in fact existed in the minds of some businessmen — 
it has also created a situation that has led agents sometimes to do 
things that I don't think they should have done in the first place. 

But even if we discount all that, and admit there are comparatively 

few cases in which 102 has really been effective in forcing one thing 

or the other, and affects, let's say, only five or 
Situation Bad, Even if . «. , 

even, at the most ten, per cent of our business 

Only 5% or 10% of organizationSj T th ink that's bad, even though 
Business Affected ^ . § ^ fiye Qr ^ per cent ^^ ^ Qur bus{ 

ness and our economy is the subject of enough headaches — why add 
five per cent more in the form of 102, if it shouldn't exist? 

There have been some instances in which 102 proved a definite 


stumbling block. In one case it stopped a program of expansion that 
should not have been stopped. It is a peculiar situation, and I'll give 
you the circumstances, because again you probably won't find them 
in another case. It happened to involve a top company that was 
classified under 102 as a holding or investment company, and of 
course that's behind the eight ball right off the bat. Originally it had 
been an operating company. It had gone through the wringer twice, 
once in a sort of informal, non-court reorganization, and the second 
time through 77-B. But it did wind up with a substantial interest in 
three operating companies — chain store operations — and they came 
to the point where it was desirable to expand substantially the opera- 
tions of one of the chains in which they had a major position. These 
operating companies were not subsidiaries. I don't know whether 
they actually have 50 per cent in two of them; they did in the third 
that they wanted to expand. In the other two I don't think they have 
50 per cent, but they have a very substantial block, the biggest single 
unit. This top company itself was owned by a large number of stock- 
holders, but again we had a comparative handful that really had 
domination of it, so we couldn't say it was a publicly held company 
from that angle, though it did have a large number — I don't recall 
the number exactly, but it is in the thousands — of stockholders. 

Now they were in a very peculiar position. They didn't want to 
have this operating company borrow money or issue new capital, 
except as they could issue it pro rata to all the common stockholders. 

That meant, of course, they had over ko per 

, n . , k Desirable Expansion 

cent interest, and would have to take up 5o per 

cent of the stock offered to the stockholders 

under rights. Where were they going to get the money to put up that 

50 per cent? Their whole assets consisted — well practically all, with 

maybe a few thousand outside, and a little cash balance — of the 

investments in these three companies. If any dividends they got were 

not distributed, they were definitely vulnerable under 102, because to 

start with, it was an investment company. 

The question was raised, can we borrow money now, invest it that 

way, and then use future income to pay off the debts? We couldn't 

tell them that was safe, because if that's proper, why they could do 

anything by borrowing the money in advance, which they couldn't do 

otherwise. We finally found another factor, too. The truth of the 

matter was that while they had a big book surplus they actually had 

a tax deficit, but unfortunately the tax deficit was not enough to 

permit them to accumulate earnings to make up the deficit and then 


go ahead with this financing — it wasn't enough. In that particular 
case, the financing was not accomplished. The expansion did not 
take place for the simple reason that 102 stopped that top company 
from getting the necessary funds to put back into these operating 
companies, in order to permit the operating companies to expand. 

So what they had to do, since they couldn't cut out dividends al- 
together either, because there would have been considerable com- 
plaint, I should say, if not more, by the minority stockholders in this 
other company if dividends had been cut down materially, was to 
go ahead on a small approach to the major basic expansion program 
that they had in mind. Now that was, in my mind, about the only 
real case I've ever had where 102 could be said to be a dominant 
factor in preventing what would have been a normal business opera- 

I have seen other cases in which 102 has had its effect on methods 

or things that were done. For example, I think it has been particu- 

_ , _. . larly responsible for some debt financing that 

Debt Financing . * A . _° 

might not otherwise have been handled on a 

debt basis. It is true that, in a lot of cases, we can say debt financing 
is better anyway, because you get a deduction for interest, but some 
people feel that it is more conservative businesswise to have a stock 
financing operation. Looking at it from the point of view of the 
stockholder, he is in this situation: when the new stock financing pro- 
duces not only equal profits, but more profits, the only thing to do 
with the money is to distribute it in dividends, and then the con- 
trolling stockholders, or those who start in with control, will simply 
be getting more dividends to pay out in taxes. They are far better 
off to issue a debt security and use the future profits to pay off that 
debt, and wind up later with a company that has enhanced in value, 
but they still have all their stock interest. 

We have also seen situations in which there have been either ex- 
pansions into fields that were entirely foreign to the former business, 
or expansions of that business, largely because of the effect of 102. I 
won't say that it is controlling. You never can tell, because I don't 

believe anybody actually has gone into some- 
Influence on . . , , . . . 111 

thing hopeless just because of 102, and that they 

never would have done it without 102. Most 

of the time they are thinking in terms of wanting to do something, 

and maybe the risk of losing the money is counterbalanced by the 

risk of paying the tax under 102 if they don't do it. They feel they 

are running the risk either way, so they might as well run it by 


going into some new venture or expansion of their existing venture. 

There's one factor which hasn't been mentioned which, in the past, 

has been an important factor in the smaller companies. If you will 

talk to the Bureau in Washington, they will tell you they think it is 

all right as far as 102 is concerned, but I've seen 

. T , , t . . , Combined Effects of 

no case on it. I don t know what an aerent would 

r™ i_ r « • 102 and Estate Tax 

say. There are a number of small corporations 

in which there are, say, a handful of stockhold- 
ers who own most of the stock, and let's say they are companies that 
have been going on for some time. There you run into the combina- 
tion of 102 and the estate tax that was mentioned before, but in a 
somewhat different way. 

We know, because it has been done in the past before we started 
to worry about 102, that where a corporation has accumulated enough 
funds so that if one of its older stockholders dies and his stock has 
to be sold in order to pay the estate tax, or for other purposes, the 
corporation would be in a position to buy back his stock, and thus 
perpetuate control in the group of stockholders that has worked to- 
gether for a period of time, and successfully. Otherwise the stock may 
be sold outside. Who knows who will get in, what disagreements that 
will cause, and how that will upset the corporate operations? That 
has been a factor in the past in leading some companies to accumu- 
late funds to prepare for that eventuality. 

There is a serious question in my mind as to whether a taxpayer 
can today rely on that as a means, or a basis, for accumulating funds. 
We argue it in some cases. Whether it will work or not, I don't know. 

But that is a fact that it seems to me ought to be recognized, be- 
cause I think that's one of the things that will help perpetuate these 
smaller businesses and will tend to prevent some of these quick sales 
or forced sales, where you have a combination of the two factors — the 
possibility of the estate tax requiring a disposition of a substantial 
interest, which might then get into adverse hands, and result in a 
group of stockholders who do not cooperate, with an adverse affect 
on the operations of the company. 

I would like to see, and I think it can be done, the Bureau at 

least publish some ideas of the things that it 

.-■n . , r • r Need for Bureau to 

will recognize as sound reasons for retention of 

funds. I've always felt that if that were done and 

t c ,- r , Reasons for Retention 

you got to the courts on some of these cases, 

you'd probably be more successful, despite this World Broadcasting 

decision, which came out recently. 


I think Mr. Rudick made the comment that it gets down to the 

question of the evidence and the people who are giving it, and the 

credibility of what they have to say. Sometimes I have the feeling 

that some of our clients will come to us to give us a fine story about 

why they need the money, but I'm not so sure 

Credibility of j bdieve them myself! G n the other hand, I 

have others who have less idea of what they want 
to use the money for, but I think they know that they need it, and 
I think that's really what you face. That's why, very often, when I 
get into a case I put the first proposition — what is in your mind, what 
do you plan to do? Sometimes that settles their own minds, or, as 
Mr. Rudick said, you reach the point sometimes, where it is still 
cheaper to pay 271/2 or 381^ per cent, if you have to, and run that risk, 
rather than pay dividends subject to 70 or 80 per cent individual tax. 
That's about the sum and substance of what I wanted to say at 
the moment. 

Discussion of Statement by Walter Cooper 

Mr. George: Have any of you gentlemen any comment as to what 
you would have done in the situation just described — what was it, a 
chain store situation? 

Mr. Cooper: Holding company proposition, I probably said chain 

Mr. S. A. Smith: I'd like to ask why it wasn't possible for the 
operating company to borrow. 

Mr. Cooper: They did not want to have the operating company 
borrow more for that purpose. 

Mr. S. A. Smith: Was there a sound reason for that? 

Mr. Cooper: They felt it was not a good business proposition for 
the operating company to borrow more for permanent investment in 
store locations. 

Mr. George: Would you yourself consider that that's a reason that 
could be sold to the Bureau to permit the holding company to ac- 

Mr. Cooper: Yes, because they didn't think it sound for the op- 
erating company to borrow more money, but I don't know that the 
Bureau would agree. 

Mr. Dixon: There have been one or two cases where they haven't 
permitted the parent company to accumulate 
funds that the subsidiaries need. 
Parent Company ^ Cooper: This was not a parent company. 


Mr. Dixon: Yes, but even in the case of a parent company, the 
Bureau's decision has been that the parent was not permitted to 
accumulate funds, even for the needs of its subsidiaries. They con- 
sidered them legal entities. They have to finance by themselves. 

Mr. Rudick: In that holding company case, why wasn't preferred 
stock issued by one of the operating companies? 

Mr. Cooper: The people who were operating it felt that it ought 
not to be done. This particular company had no preferred stock out- 
standing. They probably could have gone to insurance companies. I 
suppose possibly, also, the question of the price at which they might 
have been able to sell the preferred stock might have been a factor 
too. I don't know what entered into their decision, but they didn't 
want either preferred stock financing or more borrowed money. 

This is the type of expansion that really should not have been on 
borrowed money. I mean, it was a long-term expansion proposition, 
and it involved facilities rather than just inventories. What they really 
had in mind, as I understand it, was that they would cover, by com- 
mon stock financing, the so-called permanent in- 

, - - ,, c . Expansion Prevented 

vestments, and then they would finance the 

inventory part of the operation through borrowings, if they needed 

to. But of course, they couldn't do the financing of the inventory 

part until they had the other part done, and that never was done. 

Mr. George: Mr. Cooper did suggest a question to me that I'd 

like to raise for consideration later, if there is time. It is a general 

question. He made the remark, a rather wistful remark, to the effect 

that he would like the Bureau to publicize what it would recognize 

as sound reasons for preserving funds. The 

- ^ , u i-i • i • Publicity on Bureau 

question that I would like to reserve is this. 

What would the consensus of feeling be among 

this group as to how much further the Bureau could go in particular- 
izing its standards of legality and illegality, or whatever the proper 
words are, liability and nonliability, for the retention of funds? 
Mr. Kurzman, please. 

Statement by Harold P. Kurzman 
President, Lily of France, Inc. 
Mr. Kurzman: Gentlemen, I'm one of these small businessmen you 
hear about. I'm a manufacturer, and I'm in the needle trades field. I 
certainly wouldn't presume to discuss the law or the economic angles 
of 102, but as I listen here today I have a few random observations 
I'd like to throw out, for whatever they may be worth, giving a little 


thinking in the light of what I think is the small manufacturer, the 
fellow in the needle trades, who worked his way up, owns his own 
business generally, and is really a small operator. 

In our industry, which does around $300,000,000 a year, I would 
say the number of firms who do over $3,000,000 a year could be 
counted on both hands, although I will admit that in dollar volume 
they show a large proportion of the volume of the industry. 

But from the viewpoint of an association, for example, representing 
maybe three, four, or five hundred of these manufacturers, they are 
small manufacturers, but they are the basis of a lot of our American 

I was particularly impressed with what Mr. Austin said this morn- 
ing. I think it applied particularly to our industry and people like us. 
He spoke about my industry and its character- 
Particular Effect on istics which are: the fact that we don't have very 
Small Business much capital investment, the fact that the main 

problem is distribution, characterized by a high 
turnover; and particularly the fact that stock is closely held, either 
by an individual or a small group of individuals. Such industries are 
particularly affected, I think, by 102. 

I'd like to comment on the four words that I've heard repeated 

during the day, which I think again apply particularly to our people. 

These words are fear, uncertainty, apprehension, and ignorance. These 

were all used by previous speakers at least once, 
Fear. Uncertainty. , T , £ ■,. 

and many times. I got the very strong feeling 

ppre ension an ^j. t j iat j s particularly important. Around this 
table we have accountants, lawyers, and busi- 
nessmen, and on the whole pretty clear, orderly thinking. The average 
businessmen of my group don't think that way. They are moved much 
more by emotions, and these elements are very important in their 
thinking, and in the definite decisions that they reach, and these 
decisions affect their business, and in turn affect the economy of the 

I have to inject a word peculiar to our business, the word "hot." 
In the ready-to-wear business, the needle trade business, there are 
some organizations which go on for over fifty years, as our particular 

company has, but even those are affected by 
Peculiar Hazards of ^^ ^^ q£ ^^ and failur ^ depending 

Needle Trade Qn whetherj in the terms f t he trade, you are 

" ustry hot that year or not. That was put more elo- 

quently by a previous speaker, pointing out that it is important that 


there be a tolerance for unfavored industries. Particularly in the 
needle trade business there is a need for that tolerance, because not 
only you don't know, from year to year, how hot your line is going 
to be, but when it comes, it comes very suddenly, and you have to 
be ready. You have to have the capital, you have to be ready to move 
and take advantage of it while it is there. You can't plan, as you can, 
for example, in the electrical industry. If you are going to make a 
vacuum cleaner, or something similar, you can survey the market, 
and you can determine what kind of a product you are going to make 
and what price bracket it is going to fall in, and what the consumer 
demands, and how you are going to distribute it, and what your need 
for capital will be, and all that sort of thing. 

Our particular type of industry, is a little bit different, and I hope 
you will understand the words that I am trying to use. 

One other comment — somebody mentioned the fact that one of the 
bad things about 102 is that it brings forth unsound business prac- 
tices. We have seen that in many cases, where, for example, textile 
manufacturers accumulate an inventory and „ . 

take goods off the market, and manufacturers 

, , . . . , , Unsound Inventory 

and plants have to either close or slow down 

, , , , , , , , Accumulation 

ana send labor home, because they can t get 

material when they should have it, because somebody is holding on 

to it for secondary reasons. 

We've also had several cases, I'd say, where we've been asked not 
to pay our bills, to put our payments over into the following year, or 
the following fiscal year for some other people, and similar things of 
that kind which, in my opinion, are unsound business practice, and 
anything that is unsound, like sin, I'm agin it, and I'd like to go 
on the record. 

I think that will end my comments at the moment, thank you. 

Discussion of Statement by Harold P. Kurzman 
Mr. George: Might I ask this, Mr. Kurzman — what do the people 
whom you spoke about, with their special difficulties and their limited 
understanding of these laws, what do they usually do? 

Mr. Kurzman: Well, first of all, talking in terms of that invest- 
ment average, the average fellow in the needle work trades, is think- 
ing about selling. He is thinking about selling his line and designing 
something new and making this garment at a profit. His second 
thoughts, when he has them, is how to manufacture it and how to 


manufacture it profitably. He very seldom comes around to thinking 

in terms of financing and the problems that are involved. 

He does have a bookkeeper, or in some cases a comptroller, who 

looks after that end of the business for him, but it is far weaker in 

its relationship to management and so on, than it is in many other 

types of businesses, and then, of course he has 

his accountants, and you say, well, the account- 
Average Businessman . , . . . . . , ^ „_, ^ . 

ant should advise him on that. That is very true, 

in Needle Work . . , , , _ 

and there are many good accountants and a lot 

of our people have excellent advice. But, in many instances they are 

comparatively small and perhaps can't buy the same quality of advice 

that a large steel company or an automobile company or some other 

large textile company can, and very often they can't think in the same 

terms as the man who is trying to advise them. In my opinion they 

are at a great disadvantage then, in that respect. 

Mr. George: Do you think they have taken out more than they 
should because of either advice or fear? 

Mr. Kurzman: I do, yes. It is a very hard thing to prove. It is a 
very intangible thing, dealing almost in the realm of psychology, but 
when a person makes a decision emotionally he is more likely to be 
influenced by fear and by that intangible thing. 

Mr. George: Is there any question anybody would like to ask Mr. 
Kurzman on this situation in his particular trade? 

Mr. Cann: Do you see any effort, Mr. Kurzman, in your industry, 
of making large inventory commitments at the 

Inventory Commitments ^ q£ ^ ^ ^ ^ WQuldn>t otherw i se 

make, if it wasn't for 102? 

Mr. Kurzman: I don't see it so much on our side of the fence, 
as I do on the people who supply us. We see it very definitely in manu- 
facturers and distributors of textiles. 

Mr. Cooper: You mean> they hold up shipments to you? 

Mr. Kurzman: They hold up shipments to us. Now, there may be 
various reasons why those inventories are accumulated. I couldn't 
attempt to determine how much of this decision was guided by 102 
and how much by other factors, but I have a hunch that 102 plays 
a part in some of the decisions. 

Mr. Cooper: Would you say that was true at the moment, even 

Mr. Kurzman: I think it is less true at the moment. 

Mr. Rudick: Do they ever ask you to hold up payments? 

Mr. Kurzman: Yes. 


Mr. Rudick: For that reason? 

Mr. Kurzman: Again, that is a very difficult thing to determine, 

because I think there are probably many factors „ 
. . . _ A . . / , i Payments Deterred 

that enter into it. To some extent it is balanced 

out. Some people want to pay ahead of time, and others don't want 

to receive it, so it balances out. 

Mr. Rudick: Well, that may be. I only comment, because I was 
afraid it might affect this 102 situation. 

Mr. Ayers: It seems to me, Mr. Rudick, we're talking about indi- 
vidual cases where there is hardship, and the 

r , r 11 • • 1 ^t *r ■, , Discriminatory Effect 

fact that one fellow is going to be O.K. doesn t 

do this fellow any good who is being hurt. 

Mr. Rudick: Well, I mean the over-all economic effect. 

Mr. Ayers: Well, yes, that is true in the over-all picture. 

Mr. S. A. Smith: Then you have the situation where one of 
these practices bounced back the wrong way. It happens to be a 
case I just got into recently. Back in 1945 the company was in busi- 
ness making candies. I don't know whether you know about it, but 
of course December 31 is the low point in the candy business. Christ- 
mas is the big time, and come September, of course they are loaded 
up, producing for the Christmas and holiday trade, and come Decem- 
ber, why they are way down the bottom. In the latter part of 1945, 
seeing what was happening, the company decided to splurge, and 
went into the cocoa market and bought a lot of cocoa and a few 
other things, with the result that they got a tremendous amount of 
money in 1946, because prices went up like that. 

Well, in '46 and '47 they kept going ahead and they were still 
way up ahead on inventory and on their commitments and pur- 
chases, and then, of course, it started to go the 
other way. They were afraid the market was Prediction Difficulties 
going down, and they forgot about 102, with 
the result that they got by with 102 for '45, but they were in an awful 
spot for '46 and '47. 

Mr. George: We'll hear next from Mr. Piatt. 

Statement by Joseph S. Platt 

Porter, Stanley, Treffinger & Platt, Columbus 

Mr. Platt: I'm the only country lawyer on the list, Mr. Chairman 

— I mean a tax lawyer not practicing in either Washington or New 

York. I've taken the precaution, in view of that fact, to talk to some 

of my brethren and colleagues and what I'm going to say represents, 


to some extent, the composite experience of several persons having 
the same type of practice. 

In the first place, I would assume that our focus is entirely on 
closely held corporations. I haven't been clear as to some of the 

things that have been said. Perhaps there is an 
Effect on Closely .. . . . , , , ,j 

implication that some widely held corporations 
Held Corporations . n , ^ , , . T 

are influenced, to some extent, by 102, but I 

would doubt it very much without some pretty clear evidence. Among 
closely held corporations I would definitely include the type in which 
the corporation is dominated by a small group or family, even though 
a portion of its stock is widely held. 

The only question I've ever been asked on 102 by a widely held 
corporation had to do with whether or not the statute has any refer- 
ence to the accumulation of earnings by subsidiaries — the avoidance 
of the corporate surtax, the 5.7 per cent tax on intercorporate divi- 
dends. I think the answer is fairly easy under the regulations. The 
statute doesn't have anything to do with that situation. I mention it 
merely to indicate that it is the only type of question that I've ever 
been confronted with by a widely held corporation. 

I have some misgivings about this next point in view of some of 

the other testimony. I would say there are about 

Situations Where 102 , . • , r 

three situations, and in my experience only 

three — and some of those I haven't experienced 
personally — where 102 influences a corporation to pay dividends which 
it would not otherwise pay. 

The first and I suppose most important from the point of view of 
the country at large, is the dividends that are paid out through ig- 
norance. I have no idea how widespread that is. Last summer a friend 

of mine came to me and exploded, "Say, what is 
Payment of Dividends ^ ^ ^ j .^ heard abom? ^ ^ outrage# 

>ug gnor Four or five weeks ago our accountant said we'd 

have to pay out all our earnings to our stockholders. So, we went 
ahead and did it." Well, I questioned him a little bit about it, and it 
developed that he had a perfect case, an ironclad case under 102. The 
corporation was in a very vulnerable position, and there was a pros- 
pect of losing some of its major business and accounts. It was really 
running into trouble. There are indications that there is a widespread 
lack of knowledge, and action through fear. Perhaps the answer is 
for the National Association of Manufacturers or the Chamber of 
Commerce or other trade associations to be more explicit in their 
material on this statute, and give a little more education on the sub- 


ject. Of course, the answer that appeals to me more is to encourage 

these people to hire a tax lawyer and get some real advice on it. 

Well, the second category that I would suggest in this matter of 

paying more dividends than would otherwise be paid, is this: Where 

a corporation in a particular year would probably normally pay 55 

or 60 per cent in dividends, or pretty close to .-,. . ,' . ., , 
r r ; Additional Dividends 

70 per cent, they may push it up a little bit and 

pay out 70 per cent, with the thought that this will, in all likelihood, 
avoid any question being raised. Of course it won't, it isn't a guar- 
antee at all, but it does help, and so I think you might very well have 
some additional dividends paid by corporations which are pretty close 
to the 70 per cent line. 

The third category I have had very little experience with. In only 
one instance has it seemed to me to be rather significant. In corpora- 
tions where you have a lot of stockholders own- _. ... . _ , . 

' Dividends Resulting 

ing perhaps 50 per cent, and a family group ^ ^.^ ^^ 

owning another 50 per cent, your directors have 

two groups breathing down their necks: the , _ 

, , , , , . Q"d Treasury Agents 

small stockholders who may have an action 

against them if they incur the tax, and the Treasury agents. In that 

situation I would expect the directors to lean over backwards, and 

perhaps pay out more dividends than they would otherwise. 

There's another category which probably doesn't belong in this 

group at all: that is the closely held small corporation which is 

officered by its shareholders. Such a corporation „ rr _ , . 

; iii Effect on Salaries 

may, if it becomes more vulnerable, attempt to 

reduce its earnings by increasing salaries to the extent that it thinks 
it can do so within the reasonable salary requirement. 

In all other situations it has been my feeling that your policy is not 
affected. Usually when you explore the thing with the management — 
get them to thinking like businessmen, instead of tax lawyers — you 
find that they have ample justification for retaining the earnings that 
they want to retain, or that they think they have, and that their 
bona fide belief on that subject can be made a matter of record. If 
not, it may be that the rate comparison, even if the surtax is assessed, 
is so favorable to retaining the earnings that they would not pay divi- 
dends anyhow. That sometimes happens. Of course, I'm not speaking 
of my own clients in this latter type of situation. 

One other situation which is not exactly a 

-,..,, ~ . . n Effect on Bonuses 

matter of dividends: Section 102 may influence a 

corporation to be slightly more generous with its key employees by 


way of bonuses than it otherwise would be. I think that sometimes 
happens. Now, aside from dividends, on the other side of the picture, 
what other year-end activities are influenced by 102? 

Well, in the first place, of course, the minute book is very definitely 
influenced by 102. That has no economic repercussions, I assume, al- 
though I have sometimes felt that the careful, well-considered thought 

given to the corporation's year-end position and 
Consideration or " . , . . . . . , _ _ 

future needs, which is induced by Section 102, 
Year- End Position _ , , . . , ' , 

may perhaps be a good thing m the long run. 

I think it does induce a real, genuine stock-taking on the part of the 
management which, if they can be persuaded to think like business- 
men and not like tax lawyers, is a good thing. Sometimes a corpora- 
tion with heavy accumulations of cash and government bonds, will 
feel that it is an advantage to reduce those liquid assets, by paying 
off debts, acquiring needed inventory, and in other ways too. Many 
people feel that a shining target of cash and government bonds is some- 
times troublesome, and that if the corporation can be put in a less 
liquid position legitimately by paying off debts or in other ways, it is 
all to the good. One thing that is sometimes done is the retirement of 
preferred stock. That cuts both ways, I understand, but I am inclined 
to think that the balance is probably in favor of doing it, if you can 
do it without running afoul of the dividend tax. 

A third year-end activity that's been suggested is the window- 
dressing type of transaction: making an unnecessary bank loan, the 

artificial increase in accounts receivable, the ac- 
No Window-Dressing ... r , , . . T , 

quisition of unneeded inventories. I never nave 

seen anything of that at all, and I doubt very, 
very much whether it is of any significance. I bow to the rest of you 
on that, as you've had more experience, probably, than I, but I would 
question very seriously whether there was much in that point in 
connection with 102. 

Another year-end activity which has been mentioned considerably 
here, is the matter of capital expansion and capital expansion com- 
mitments. Here again I just never have met any 
api a pansion businessman who would make a final commit- 
ment of funds, in expansion or otherwise, which 
he wouldn't otherwise do, simply by reason of Section 102. I don't 
think businessmen act that way; none that I've seen have gone out 
and spent the corporation's money in a way they didn't want to do, 
a nonbusinesslike way, simply because they felt they were pushed into 
it by Section 102. So far as capital expansion is concerned, it seems to 


me that about the only effect of 102 is in the planning stage. You 
probably get more long-range planning and more careful considera- 
tion of your steps with 102 on the books than you would otherwise get. 

So much for the year-end activities. 

Now there's one other type of economic effect of 102 that is worth 
mentioning: that is in connection with new corporations and liquida- 
tions. We all know that when we create a corporation, if its balance 
sheet for credit purposes is not the vital consideration, we start it 
off poor. We lend it its working capital; perhaps we have it assume a 
mortgage. We start it off with a considerable indebtedness. We hope 
that will hold it for several years. If it is going to have to pay dividends 
in the very near future, maybe we think twice before we incorporate 
at all, assuming, of course, that it is the type of enterprise that can 
appropriately be operated as a partnership or sole proprietorship. 
After the debt is paid off in a closely held small enterprise, assuming 
that we have incorporated, the management is confronted with several 
possibilities. It can expand, if it is good business to expand, and I 
don't think it would do so otherwise. It can pay dividends. It can 
pay the penalty tax. Or the owners can liquidate and go back to the 
partnership or sole proprietorship, or sell out. 

The final alternative, selling out, is motivated, as has been sug- 
gested, also by estate tax considerations, not only the matter of get- 
ting liquid capital into the estate, but also avoiding a runaway valua- 
tion; this can cause an immense amount of trouble in connection 
with closely held stocks where the good will factor is in the picture. 

From the point of view of the economy, this matter of liquidations 

and sales is perhaps a more serious thing than any of us have thought. 

Your big, widely held corporations are not vulnerable at all. They 

can accumulate their earnings to their heart's .. .. , . _ , 

. , . Liquidation and Sales 

content. Your small corporation, when it gets to 

a point of expanding as far as it cares to, and has paid off its debt, is 

vulnerable, and it may well be that Section 102 is a factor that pushes 

such small corporations into the arms of big ones. I hadn't thought of 

that to any extent until I got here today, but it may well be an 

economic factor of considerable importance. 

Other than that, my own conclusion is that the actions motivated 

by Section 102 are not of great significance. So far as dividends are 

concerned on the one hand, and so far as spend- _. _ . 

. r . Other Results 

ing and corporate rearrangements on the other, . ; 

the statute doesn't have a very significant effect 

on the actions of businessmen. That's all I have to say on the subject. 


Discussion of Statement by Joseph S. Platt 

Mr. George: Questions or criticisms? 

Professor D. T. Smith: This may be a little bit irrelevant, Mr. 
Chairman, but there is one point that has conspicuously not come up 
today. I would like to toss it out and see if there is any substance to 
Th t f in? * tp *' ve fr e °t uent ty heard it stated that though a 

case might not hold in the courts — fitting in 
with your point, Mr. Cooper, as to whether the revenue agents are 
too concerned about the matter unjustifiably — in the give and take of 
negotiations with revenue agents, the threat of 102 is advanced, and 
though in the last analysis the agent concedes the 102 point, there 
will be an indirect concession on other points, such as depreciation or 
perhaps on unreasonable salaries, which might not be conceded and 
perhaps should not be conceded, but are done merely to avoid litiga- 
tion on the more serious 102. 

Mr. George: In other words, using 102 as leverage? 

Professor D. T. Smith: Yes, using 102 as leverage in getting indirect 
effect. Among the practitioners, who have been in on negotiations, is 
there any substance to that or not? 

Mr. Silverson: I would testify strongly in the affirmative on that. 

Mr. Austin: Yes, but if you will look at the number of 102 cases 
that have come up before the Bureau, it is not very significant. 

Mr. Rudick: There's always a simple answer to that. Turn it over 
to the revenue agent. I haven't had much of that. Frankly, we've had 
very few cases in which that was involved. 

Mr. Dixon: Well, we had a case of that kind in the examination 
of our 1941 tax. We were attacked not only on Section 102, but also 
on the expense items and on the depreciation items. There was only 
one on which we gave in. It was the question of the loss on the 
purchase of stock held by an individual in the company — an employee 
who had died. We purchased back the stock at a lower price than he 
had paid for it — I mean, lower than the book values. It didn't amount 
to too much, and we conceded that one point in the negotiations. But 
this definitely would not have been conceded had it not been for the 
other questions involved, and rather than get mixed up in all those 
other features, we conceded that one point, although I think we were 
right in the way we looked at the case. When the agent couldn't get 
a 102 concession, he attacked on the expense items and on the de- 
preciation, and then on this other, the repurchase of the stock. 

Mr. Turner: Have any of you met a businessman who made a 


final commitment for funds because of 102 alone, which he would 

not have otherwise made for good and sufficient 

, r 1. 1 Expansion 

reasons? What about the general feeling on that? 

Do the rest of you subscribe to that? 

Mr. Piatt: No, I make my statement even stronger than you put 
it. I don't think that in the final analysis Section 102 enters into that 
decision at all. I think it is perhaps recognized that the expansion 
will help the corporation, but in the final analysis, the decision is 
going to be made on business grounds, and business grounds alone. 
That has been my observation of the way businessmen operate. 

Mr. George: I think the point is important. 

Mr. Cooper: I don't know how far you can go on the question of 
commitments, but I can say I know of two cases, not long ago, where 
these things were done. Definitely there was contemplated expansion 
in the picture. Now they went out and got architects and had the 
plans all drawn up, and I know very well they wouldn't have done it 
if it hadn't been for 102. Now that isn't a complete commitment, but 
certainly that is spending money that wouldn't have been spent. 

Mr. Piatt: Well, I agree with you there. The advance planning 
and planning ahead for a substantial capital expansion, which is 
going to be needed, and on business grounds is wanted, will be influ- 
enced by 102. The management thinks ahead and makes a record of 
its planning activities. 

Mr. Cooper: Now that's spending money for it. Now they did not 
know. In fact I know of one case where they finally scrapped the plans 
and had new ones drawn up. I know of another case in which they 
bought the land, but were not sure they wanted to put the building 
where they bought that land. 

Mr. Austin: Well, I've seen cases where, well, two types of situa- 
tions, one where purchases of looms were certainly indicated to reno- 
vate and rehabilitate a plant, but barring 102 now would not have 
been the time, both because of price situations, and because of uncer- 
tainty of present business conditions. But they didn't dare let their 
projected program, which justified nondistribution two years ago, 
lapse altogether for an indefinite period. That is one situation. Now, 
of course, that's not 102 alone, but strongly motivated by it. 

Mr. George: That's the immediacy issue again. 

Mr. Austin: Another type of case — about two or three years ago — 
was where a company that used piece goods, and so on, bought a 
mill which otherwise they wouldn't have bought, but they figured that, 
well, we can use the material, we'll spend so and so much, maybe 


we'll lose money on it. What's the most we can lose? We'll match that 
against the Section 102 penalty we otherwise would have had. Now 
again, I'm not arguing the frequency of this. I said in my own state- 
ment that I didn't think the over-all effect was significant. But there 
are such cases. 

Mr. George: Just by way of experiment, would you mind a show- 
ing of hands as to the number of cases where expansion has been pre- 
cipitated primarily by 102 that would otherwise not have taken place? 

Mr. Cooper: Not otherwise have taken place at all? 

Mr. George: Within the reasonable future. How many of you 
would feel there are a number of these situations? 

Mr. Piatt: Are you talking about the actual final decision? 

Mr. George: Yes, I am. 

Mr. Piatt: I would say I have never seen any. 

Mr. Maloney: In other words, the decision to do it now, instead 
of saving the money and waiting? 

Mr. George: Principally, yes, but it doesn't absolutely have to be 
something that would be done eventually, as I meant my question. 

Mr. Cann: Well, there doesn't seem to be any feeling that it is a 
mass movement. 

Mr. George: I'm only talking about people who are regarded as 
normally subject to the hazards of 102. 

Mr. Cann: Of course, Mr. George, you used the word primarily, 
and I couldn't go along with that — primarily. 

Mr. George: I had to use it. 

Mr. Cann: But, as a substantial factor, I would raise my hand. 
I've seen any number of specific instances where it was a substantial 
factor in their determination. 

Mr. George: Any others feel that way? 

Mr. Cann: I have had cases where the decision has been acceler- 
ated by it, in other words, maybe one or two years ahead of the time 
when they would have ordinarily proceeded. 

Mr. Dixon: Well, if the word primary means they threw the 
money out of the window, I would subscribe to say absolutely no. 
But, I do know of many instances where increased expansion has been 
greatly influenced and with respect to such matters in certain fields, 
as inventory commitments, I have seen it repeatedly. 

Mr. George: Well, I was thinking of cases where a man might 
invest his money in something that would have a value, even though 
it were not absolutely necessary to his business. I don't think he would 
throw it away. 


Unidentified Speaker: I think that is fundamental in any busi- 
ness procedure. If you start off right, suppose you forget about taxes. 
Your first problem is — here's a plant, it cost me $100,000 to build it 
or buy it, as the case may be — is it worth it, am I going to make 
enough money out of it, am I going to lose my shirt on it? Well, sup- 
pose that's one answer. 

Now, your next problem is — all right, there is a possibility now, I 
won't lose my shirt, but it is worth $100,000 and I may make some 
money out of it, or I might lose a little bit. What is my alternative? 
Run the risk of 102, or pay it out in dividends and have less than 
$100,000 by far, out of it, and then see what I'm going to do with 
the $30,000, let's say, that I have left out of that $100,000. Now maybe 
he wouldn't buy that plant at $100,000 if that were the only considera- 
tion, but these other factors do enter into it. 

Mr. George: Well, I think all these qualifications are good. 

Mr. Cooper: Well, I have come across a number of cases where 
companies have bought plants that were not going concerns, that is, 
were losing money, in order to offset the profits in other plants. I 
think there are a goodly number of those. 

Mr. George: Only when they thought they could make them prof- 

Mr. Cooper: Well, there have been instances where they thought 
they would lose less that way than the other way. With a chance of 
making a go of it, of course. 

Mr. George: In other words, they wouldn't think it worth while if 
they had to sustain a loss. 

Mr. Cooper: But the portion that they would have to stand would 
be small, after taxes — they'd be better off than by paying dividends, 
and taxes on them, with no chance of developing a profit. 

Mr. George: Well, as a matter of fact, that could be true of ordi- 
nary taxes in the case of unincorporated enterprises, let alone 102. 

Now, what would a businessman from Chelsea say? 

Statement by S. Abbot Smith 
President, Thomas Strahan Company 

Mr. S. A. Smith: I am another one of these small businessmen, 

making wallpaper in a small factory up in Chelsea, Mass. Of course, 

I've been interested in the situation with a lot 

of other small businessmen in that New England % esprea 

T , . , . .°, But Profits Retained 

area. I got in touch with quite a number of them 

in this connection. It is amazing the widespread fear there is on 


this subject. It is practically everywhere. They are all worried as can 
be. But in practically all cases they say, well, we're going to go ahead 
and do it anyhow, because we can't afford to pay out the money. So 
I think the fear is there, and in the very small cases, there is a lot of 
ignorance, and there is everywhere a lack of accurate information 
in regard to it. 

Apparently in a great many cases they go to their accountant, their 
accountant calls their attention to 102, and then generally ends up 
by saying, well, it is up to you to decide whether you will take the 
chance or not. 

I think when that 70 per cent question was on the income tax blank 

that was really what started the ball rolling in a big way. Everybody 

was asking about it and was worried about it. I know we paid out 

more that year than we would have otherwise. 
Company Paid More „ . f „ . . , , , 

„ . If the following year had turned out to be as 

Than Was Wise 11 • • 1 , T ^i_- 1 -. 

poor as we thought it might be, I think it 

wouldn't have been very pleasant. But as it turned out, the year was 

better than we expected, and it didn't do any harm. I think that was 

true of a lot of others, who were in much the same boat. 

I know of a number of accountants who told their clients then 

that the real question was whether it wouldn't be better to keep the 

money, in view of the outlook, and take a chance on the penalty. If 

they had to pay the penalty then they'd say they 
Small Businessman's ' . r ' r ' , , ' 

paid that much money, that much cash to get 
Difficulty in Getting r . . , ' , , , ° 

the money, but they had the money, whatever 

was left of it. If they paid the money out, they 
didn't have it, and in the case of a small company they had a great 
deal more difficulty in getting it. That has been one of the difficulties 
of the average small business, that he has to build up these reserves, 
as much as he can, because he hasn't any other place to go for other 
money when he needs it. I think that's one of the big problems now. 
You speak about this equity capital situation, where he couldn't get 
equity capital — that is even truer of the small business than it is of 
the larger ones. His only resources are his own. 

One of the things that impressed me very much in Mr. William- 
son's memorandum here — I don't know whether you noticed it or 
no t — was those figures that he gave about the cases closed before 
July, 1939 and closed since 1939. I was very 
much interested to see that in the case of those 
closed by the income tax unit — you notice they collected a very small 
proportion of the total tax proposed — $13.2 million out of $66.7 mil- 


lion, and in those closed by the courts $27.1 million out of $104.5 
million. However, when you come down to the next group there, 
closed by revenue agents, they got $14.5 million out of $16.1 million, 
and from those closed by technical staff, they got $3.5 million out of 
$5.4 million, and they got §622 thousand out of $672 thousand closed 
by the Tax Court. 

Summary of Cases Closed Under Section 102 or Similar 

Provisions of the Internal Revenue Acts a 

Cases Closed Prior to July, 1939 

(Irrespective of the Tax Year Concerned) 

No. of Cases Tax Proposed Tax Collected 

Closed by Income Tax Unit 483 $66,795,655.00 $13,275,091.00 

Closed by Tax Court of U. S. or 
Other Courts 311 104,519,928.00 27,184,657.00 

Totals 794 $171,315,583.00 $40,459,748.00 

Cases Closed from July, 1939 to June 30, 1949 
(Only with Respect to 1938 and Subsequent Tax Years)'** 

No. of Cases Tax Proposed Tax Collected 

Not Liable 556 $ 12,543,180.00 $ 

Closed by Revenue Agents 723 16,150,648.00 14,597,091.00 

Closed by Technical Staff 168 5,458,116.00 3,519,022.00 

Closed by Tax Court of U. S. or 
Other Courts 30 671,990.00 622,288.00 

Totals 1,477 $34*823,934.00 $18,738,401.00 

Open Cases on July 1, 1949 
Total Open Cases Pending on July 1, 1949 156 

a Data supplied by Dr. T. C. Atkeson, Assistant to the Commissioner of Internal Revenue, 
September 12, 1949. 

b Included in these cases opposite the designation "Closed by Revenue Agents" or "Closed 
by Technical Staff" are cases for 1938 and subsequent years in which the taxpayer has paid 
the tax even though he may have subsequently filed a claim for refund and brought suit for 
recovery of the tax. Cases closed from July, 1939 to June 30, 1949, for tax years prior to 1938, 
are not included anywhere in the summary. Data in respect to these particular tax years have 
not been tabulated and, therefore, are not available. 

Now, those aren't big figures when you talk about our national 

income or things of that sort, but — and I'd like to ask Mr. Williamson 

if it is true — it looks to me as though what hap- 

j ^i_ ^ • ^t- i_ • 1 p 11 1 Big versus Little 

pened was that m the big cases, the fellow who 

had the money to go to court and fight the case 

won it in a great many cases, in other words, he didn't have to pay; 

but the little fellow, when the tax agent came around and started 

arguing with him, ultimately caved in and paid, rather than go to 

the expense of going to court. 

Mr. Cooper: I would doubt that. 


Mr. S. A. Smith: Well, that's what I don't know, but it certainly — 

Mr. Cann: I think the big ones went up to court. 

Mr. S. A. Smith: You think that's what it was? And I think you 
had a different economic situation there in July, 1939. 

Mr. Cann: Well, it is to be expected, though, that in the revenue 
agent's office you would have more cases closed, there being a closer 
relationship. I would gather from those figures that in the cases which 
were closed by the revenue agent it was quite 
apparent that the tax liability was there and 
they paid it, or, in the alternative, they paid it to bring suit, going 
that route rather than to go to the Tax Court. But, it is obvious with 
respect to the cases that were closed by the Tax Court, or even by 
the income tax unit, prior to decentralization, that there was a repeti- 
tious review of cases before a final decision by the courts. 

Mr. Austin: Generally, your larger company would have better 
advice and would not be likely to go in with such a weak case, isn't 
that true? 

Mr. Cann: Well, that might be true in some instances. 

Mr. S. A. Smith: Wouldn't that have a lot to do with changes in 
Bureau policy, more than anything else? 

Mr. Turner: Well, as Mr. Cann says, they probably would go to 
the district courts, because the way seems to be smoother through the 
district courts than through the Tax Court. 

Mr. Cann: Another thing too — a lot of these cases you say are 
closed by the Tax Court, probably might have been closed on another 
point beside 102, because up to last year there were only ninety-eight 
cases that had been tried in court. 

The statistics do not permit of any logical conclusion divided as 
they are with decisions for the taxpayer and for the Commissioner. 
Further, the scope of the problem is not reflected by these statistics 
because of the large volume of cases where the 102 issue is raised and 
subsequently disposed of through administrative channels. 

Mr. George: I gather these figures will not include all those situa- 
tions which the agents open before they issue their report and argue 
out with the taxpayer and then never issue a report. You know there 
are cases in which the agent never issues a report. 

Unidentified Speaker: Well, these statistics are far from complete. 

Mr. George: Well, I suppose we might as well let that be the 
requiem on them. Would you care to proceed, Mr. Smith? 

Mr. S. A. Smith: The fact is that many of these small companies 
have been very careful, as Mr. Piatt said a while back, to be sure that 


the minutes of directors' meetings carried the whole story of why they 
didn't pay it out and what they hope to do, whether they ever put 
it into operation or not, in other words, a complete story. They have 
that behind them. 

I think also it has been influential along with the income tax, in 
increasing the perquisites of the operating per- 
sonnel, the things that the company does for ' „ , 
. r i_m / for Personnel 
them in the way or automobiles, nouses, one 

thing or another. In the case of one man I know, they supplied his 
family with a maid. We'd all like that, wouldn't we? 

But, it is important, with the fixed overhead, which is being in- 
creased so rapidly, pension funds and all the rest of it, there must be 
some way for these small companies to set up reserves to cover them, 
and I think 102 is a deterrent in that respect. 

It seems to me that two things might be done. First of all, the 
burden of proof should be definitely on the Treasury, not on the com- 
pany, to prove that it is an unreasonable accumulation. And then I 

wondered whether it would be possible in any 

1 . . Suggestions for 

way to spread it over several years, rather than 
, ' / ' j • • 1 Improvement 

look only at one year; in other words it might 

be an unreasonable accumulation for the one year, but after all, there 

are other years coming, and it might be possible to use some sort of 

average — we could ask for suggestions from the Treasury Department, 

whether that would be something which they could do. 

I think there's no question, the change in attitude on the part of 

the Treasury in its policy in the enforcement of 102 has very distinctly 

changed from what it was, and now they say _ ... 

,° . , , i_ • i Treasury Attitude 

frankly that you needn t worry about it if you 

are reasonable and honest. But, on the other hand, we all know that 

government policies change, personnel changes, and it seems to me 

that we'd be much safer to have the burden of proof on the Treasury 

rather than on small business. 

Mr. Turner: But they still raise the question, I know that. 

Mr. S. A. Smith: Well, I wrote an officer of one of our little New 
England (Boston) banks. He phoned down and said, "Judging from 
my experience here, I don't think Section 102 has ever had any im- 
portant effect on the dividend policies of my bank, but a great many 
of our commercial customers have, from time to time, made refer- 
ence to it in terms of anguish." And I think that exactly expresses 
the feeling of a lot of these small business fellows, when they consider 


Discussion of Statement by S. Abbot Smith 

Mr. George: In other words, you feel there is not a great effect, 

outside of premature gray hairs and worry? 

Mr. S. A. Smith: Yes, but I think they worry about it. I think 

it takes a lot of time and worry and I think 
Causes Worry, Expense , r , , 

they spend a lot ot money on tax lawyers and 
and Loss of Time . . . , . , 

accountants that they might have saved. 

Mr. Austin: You mean money they might have spent more pro- 

Mr. S. A. Smith: More productively, yes, right. 

Mr. George: In other words — I'd like to express this, even at the 

expense of repetition — you don't think many 
But Final Actions _ , . • j-rr r i_ ^ u 

, .„ , of their actions differ from what they would 
Not Much Affected . . .„ . . , r , . , 

have been if they had a free choice, because 

of 102? 

Mr. S. A. Smith: Well I was very much surprised to find it so, 
but that apparently is the actual situation. After all, there were not 
many, just a small number of fellows contacted, I mean just the 
group around me, but that actually is so in those cases. 

There was one man who said he never held up expansion work or 

the use of profits, but they have not met the requirements of the 

70 per cent. They have very careful records in the minutes of the 

discussion before any action was taken on dividends and so forth. He 

said that if it had been enforced, if the penalty 

had been invoked — this is a man who deals with 

quite a number of small businesses up there — it 

would have been absolutely disastrous if it had 

been applied to them in general. 

He feels it is dangerous and he says he thinks they feel that they 
are sitting on a keg of dynamite. That is his reaction to it, and 
there are many others, but all of them — well the gist of it is that 
they worry, and when they get through worrying they go ahead and 
take their business actions, as Mr. Piatt said, and go ahead on that 
basis, hoping to God nothing happens. 

Mr. George: Well, that seems to be primarily a question of evi- 
dence, rather than something to be shot at. That's your testimony. 

Mr. S. A. Smith: Yes, sir. That sums up my case. 

Mr. George: Now we're back to Washington and back to a law- 
yer. Mr. Mickey. 

Mr. Mickey is connected with the Washington law firm of Step- 
toe and Johnson. 


Statement by Paul Mickey 

Steptoe if Johnson, Washington 

Mr. Mickey: One of the greatest troubles with Section 102, so far 

as taxpayers are concerned, is that it accomplishes what it really is 

designed to accomplish. I think that the in- 

crease in the number of cries of anguish that are ■■ _ 

Part of Income Tax 

heard, as individual tax rates go up and as 

profits go up, is some testimony in that respect. Unless 102 is con- 
sidered in its context, that is, as a part of a major source of national 
revenue — the income tax — and as an aid to its enforcement and col- 
lection, we shall lose some perspective on the problem. 

The income tax is a broad measure. It is roughly attuned to three 
considerations, adequate national revenue, the necessity of maintain- 
ing a healthy national economy, and, to the extent possible, the equal- 
ization of individual inequities. Whenever individual inequities reach 
major proportions, something is usually done to correct them. 

Section 102 was made a part of the income tax law long ago, and 
it has been retained there against considerable opposition, because the 
Congress, as well as the Treasury, thought that it was an important 
aid, a necessary aid to the enforcement of the income tax law. In the 
administration of any law, there are necessarily some inequities, and 
some will arise under 102. 

Any finding that this panel might make that 102 has an adverse 
economic effect would of itself be of no decisive importance in de- 
termining whether or not legislative action should or should not be 
taken. It could only be important if it were balanced against, and 
considered in conjunction with, the importance or the necessity of 
102 to the administration of the income tax. 

I do not want to be the fact-finder for the group, but to lead up 
to the small contribution I have to make, I would like to summarize 
what it seems to me has been said to date. 

On one side of the ledger it appears that 102 has an adverse eco- 
nomic effect in an undetermined number of individual instances, in 

the form of forcing sales of businesses, forcing • 

-,..,, , , , . Some Adverse Economic 

payments of dividends, and leading to prema- 
ture expenditures of funds for inventory and 

capital goods. The extent to which the precipitation of expenditures 
may be regarded as economically unfortunate is problematical. Every- 
body seems to agree that the expenditures would probably have been 
made at some future time in any event. 


On the other side of the ledger, there has been a great deal of testi- 
mony that there is not an appreciable number of taxpayers who even 
have the 102 problem. Secondly, that only some of these that do 
have a 102 problem have any 102 liability, reducing the affected num- 
ber to an even smaller proportion. There is an 
But Not Many ... . , . r . *, t ., 

l„ , additional query in my mind as to whether those 
Taxpayers Affected « i t * m- 1 i- 1 -, 

who really have a 102 liability have a 102 liabil- 
ity which arises because of their trying to avoid surtaxes, or whether 
they have a 102 liability because they are endeavoring to accumulate 
surplus for a real business purpose, which the Tax Court or the Com- 
missioner won't recognize. I think that some have a 102 liability be- 
cause they fall within the real purpose of 102, which would reduce the 
number of unfortunate cases to an even smaller proportion. 

We have also had a great deal of testimony that some of the worry 
about 102 is due to fear, probably to a great extent reflected in the 
panic of 1946, which arose because of the 70 per cent question. When 

_ „ .1 study the decided cases I am forced to agree 

Tax Court Generous in .... ' _ , . ': . , __ . ° _ 

r kl , with Cary, who wrote the article in the Harvard 

Interpreting of Needs , _ . _ . . , •. 

Law Review 7 in 1947, that apparently immedi- 
ate needs and all tangible needs that corporations can reasonably dem- 
onstrate, are recognized by the tax collectors. The Tax Court has been 
generous in its interpretation of "reasonable needs." 

Perhaps the real problem is in the area of future and contingent 

needs. I think it is worthy of consideration whether one of the most 

_ , „ , , „ serious economic effects of 102 may not lie in its 

Real Problem May Be ., . . ; 

., , curtailment 01 lame reserves tor recessions and 

Future Needs , ,. ° , . , 

depressions. Major depressions represent the 

most serious threat to continuation of our economic system, and per- 
haps to our political system, too. I say that because there are many 
who believe that the situation which existed in 1930, if repeated under 
present political circumstances might lead to a major shift in our form 
of government. 

Any statute, it seems to me, which tends to lessen the national 
cushion against unemployment and bankruptcy is to some degree — I 
don't know how great — but to some degree a threat to our national 
economic situation and perhaps to our political system. There is con- 
siderable evidence that Section 102 may be such a law. Professor Wil- 
liamson had some evidence in his memorandum. 

7 William L. Cary, "Accumulations Beyond Reasonable Needs of the Business: 
The Dilemma of Section 102 (c)," Harvard Law Review, LX (October, 1947), 1282- 


The most interesting question that I have ever had under 102, I 
think, arose out of the desire of a very large, but closely held per- 
sonal service corporation, to protect itself against future business de- 
pressions. As an insurance brokerage, the corporation had to maintain, 
in surplus, hundreds of thousands against the possibility of return 
premiums, in the event of depression. It also needed substantial bank 
accounts for a score or more branch offices. What concerned the man- 
agement of that company at the time as deeply as these factors was 
its desire to maintain its carefully selected and highly trained per- 
sonnel during a possible repetition of the early thirties. I think there 
was an additional factor. I think that the president of the company 
was a rather humane man who looked with great trepidation upon the 
possibility of the day when he might have to send persons who had 
been working with him for years out to look for a job that didn't 
exist, somewhere else. 

Assuming that a reasonable provision for depression, with respect 
to return premiums and the necessary bank accounts for the conduct 
of their business, might be safe, the problem was whether 102 would 
permit the company to maintain a depression-size reserve for return 
premiums, adequate bank accounts, and salaries of the personnel who 
would not be earning enough, in the case of a depression, to pay the 
salaries that they might need. 

Now, obviously, it appeared too risky to make provision for all 
three of these types of eventualities in amounts which management 
deemed safe as a business measure. All provisions had to be in a liquid 
form; there was no possibility of investing in inventory or in plant 
expansion. Being the type of company that it was, it had to have cash 
— the most dangerous situation possible. There was no possibility of 
accumulating, without real danger of 102, a reserve against a depres- 
sion, with respect to the maintenance of organization and personnel. 
To the extent that that was true, and in the event of a depression, I 
am quite confident, that the effect of 102 is going to be to put a number 
of people in that organization on the bread line. That is one illustra- 
tion. I think the extent to which others have had similar experiences 
should be considered. This is a question worth exploring. 

I would like to add this to the discussion a moment ago of the 

question of the recognition by the Tax Court of the possibility of 

depression. Perhaps the illustration I gave, in so _ „ _ 

r , » , ., .,. r Tax Court Recognition 

far as it involved the possibility of return pre- 

r r . i °' Depression 

miums, is not the pure sort of question that was 

envisioned at the moment we were discussing it before, because it is 


not a question of providing against mere operating losses of an in- 
determinate character, but of providing against a liability in the form 
of return premiums, which could be demonstrated to be real. In so far 
as that sort of a situation might arise, I don't have the slightest doubt 
that the Tax Court would recognize the necessity for maintaining 

reserves against a depression. I would not mind 
Reserves Against . . . x . 

defending it in the Tax Court at any time. I 

think that the apparent refusal of the Tax 

Court in some cases to permit provision for a depression arises out of 

its unwillingness to believe the witnesses who testified that what they 

were doing was to safeguard against a depression. 

Discussion of Statement by Paul Mickey 

Mr. Piatt: You didn't pay dividends in that case, did you? 

Mr. Mickey: No, but for another reason. 

Mr. S. A. Smith: I thought when Mr. Mickey started that what he 
was doing was casting aspersions on my small businessman. But I 
noted that before he got through he was planning to have some pro- 
vision made to set up arrangements for carrying, or setting up, reserves 
for these large companies to carry them through depressions. I'd like 
to point out that I think that these cries of anguish that he thought 
were justified because it enabled the reasonable 
Little Business Has intention of 102 to be carried out and made 

Frequent Depressions them liable to income tax or payment of divi- 
dends, are not false. These fellows who want to 
set up reserves to carry them through have depressions every once in 
a while. They don't have to wait for major depressions before they 
get into trouble and need cash. When the little fellow needs money 
he goes to the bank, and the bank won't give it to him. He's got a 
bad record. That's why he needs the money. He can't get people to 
put up the equity capital that he needs, and that's why it is important 
for him to set up his own reserves. With a lot of these fellows, it isn't 
that they are afraid of paying income tax, but they feel that they 
need the money in the business, and 102 looks to them as though it is 
forcing them to pay it out. That is why they are hollering. 

Mr. Mickey: Well, let me say that I know that there are cases 
where business purposes are the real problem. But my preliminary 
point was that I think that where there are real business purposes, 
aside from indefinite contingencies and unpredictable possibilities, 
there is no Section 102 liability anyhow. There may be the fear of 
liability, which I have mentioned, but that is another thing. 


Mr. S. A. Smith: But every small business has got an intangible 
contingent purpose. That's what he's afraid of ^ ^ ^.^ 
all the time, because his business conditions . , . . .. . 

change much faster. With the large concerns Contingencies 

you've got momentum, it goes along much more 
slowly. The ups and downs of the little concern are infinitely greater. 

Mr. Mickey: Well, you're merely saying that you attribute the 
anguished cries to the type of consideration that I have been saying 
I regard as one of the serious considerations under 102. 

Mr. S. A. Smith: Well, yes, but you have set it up on a big scale, 
to take over depressions for the larger companies. If you apply that 
to everybody, well then that's O.K. 

Mr. George: May I inject here? I would object very strongly, as 
an economist — this is a little irrelevant to the discussion, and I have 
restrained myself — but if all business adopted a 1 Bu in 

policy of building up enough liquid reserves for ^T^ B ™jJJ" 
the purpose of protecting themselves against a Uquid ^^ Unwjse 
depression that was conceived in the terms of 
the thirties, it would be one of the best ways of bringing about such a 
depression. Of course, I am not forgetting the ideal of saving in boom- 
time and spending in depression, but the timing has to be a little 
sharper than seems probable. 

Mr. S. A. Smith: All I am trying to do is convince Mr. Mickey 
that instead of making the little fellow pay out, or not allow him to 
set up his reserves, what he thinks are necessary to carry him over his 
ups and downs — 

Mr. George: Yes, well I meant by my remark, and the only reason 
for offering it at all, was that I think it introduces a concept of reason- 
ableness into the problem. 

Mr. S. A. Smith: That's right, I agree with you. But the average 

small businessman isn't planning as far ahead as the larger concern. 

I think that in general he is working on a ^ ^.^ ^ 

shorter time scale, but he still needs those re- 

. , , . -, Reserves 

serves, and I think that is why he s so worried 

about this thing, because he feels that if he actually lived up to the 

law, and paid out a substantial amount, or 70 per cent, let us say as 

a rough guide, then he really would be in trouble, quite frequently. 

Mr. George: Well, that's the point you think needs to be made. 

Mr. S. A. Smith: Surely. 

Mr. Cooper: I think there might be one other observation. In 
those cases where they really are trying to avoid surtaxes and that's 


all, they probably get themselves pretty well mixed up in the process 
of doing it. That's been my experience. The fellow who doesn't really 
know what is going on is apt to get hooked. 

Mr. George: Any other comments? 

Mr. Piatt: In Mr. Mickey's recapitulation he mentioned the pos- 
sibility of speeding up a commitment for plant or other expansion by 

J ■ .. w . reason of 102. I again feel that that doesn't re- 

Speeding up Expansion °. ' . 

nect my point 01 view. I reel that your business- 
man doesn't commit himself finally to the expenditure of funds until 
he is ready to do so, on a business basis. 

Mr. Mickey: Well, my point there was that that was as far as the 
group here was willing to go. They are only willing to say that it 
does expedite or speed up some expenditures; nobody thinks that it 
is really responsible for decisions which would not be made on busi- 
ness grounds too. 

Mr. Austin: Well, expediting and speeding up compels it to be 
done at improvident prices and at an improvident time. 

Mr. Mickey: Yes, but therefore the undesirable economic effect 

extends only to the increment in the price, not to the whole of the 

amount expended. My only point there was that that reduces the 

undesirable economic effect, if any. 

, „ . „„ Mr. Austin: Well, it can also add to an in- 

Inflationary Effect . . 

nationary spiral. 

Mr. George: Will you go ahead, Mr. Maloney. Mr. Maloney is a 

lawyer in New York. 

Statement by Vincent H. Maloney 
Alvord & Alvord, New York 
Mr. Maloney: Part of the discussion today has struck me as miss- 
ing one point on the effect of Section 102. I think that probably a 
very large number of corporations, whose circumstances leave them 

„. . . , especially vulnerable to Section 102, are moti- 
Effect on Dividends , , . , ,. ., . ,. . , , 

vated almost entirely in distributing dividends 

by the effect that Section 102 would have otherwise. This is the logical 
consequence of the present rates of surtax. It would be foolish for an 
individual stockholder, who has control of the situation, to pay him- 
self a dividend subject to a high surtax if he had the opportunity to 
retain the funds in the corporation where they could be reinvested in 
his own business at a later time, or invested in some other enterprise 
by purchasing securities. 

It seems probable that as to small closely held corporations, after 


you remove all elements of ignorance, fear, and bad judgment, there 
are a great many cases where the payment of the dividend is an abso- 
lute necessity to prevent application of Section 102; and that if the 
earnings increased in 1946 and 1947, the dividends had to keep pace 
with the higher earnings. 

A typical situation was described to me by an importer whose 
corporation is a typical small business enterprise. How can he avoid 
paying out all profits as dividends and have any defense against 
Section 102? The year-end inventory is negligible. Outstanding ac- 
counts are all good. There is no investment in fixed assets. There is 
no defense against Section 102 if this corporation retains any earnings 
whatsoever. I think this situation exists as to any kind of personal serv- 
ice business in corporate form, such as an advertising agency, and any 
other business where no investment in fixed assets is required. It may be 
that this economic effect is a desirable result according to our present 
income tax theories. Whether or not we agree with that proposition, 
we must realize that this is the economic effect. 

It would be useful if this result could be established by a statistical 
study. I realize that this would be a difficult project but I am not 
convinced that it would be impossible. Perhaps statistical support for 
this conclusion could be developed by following 
a sampling approach. A fairly representative 
group of widely held corporations might be . 

selected. The effect of Section 102 would be a 
very minor consideration in establishing the dividend policies of such 
corporations over a period of years. The percentage of income dis- 
tributed by this group might be compared with the percentage for 
corporations which come under the heading I have described, per- 
sonal service, brokerage, etc. I feel certain that the relationship be- 
tween these two groups would be very much different from that shown 
by statistics based on size of corporate income. 

There might also be some value for this purpose in a comparison 

of the period from 1900 to 1913 with a period, say, from 1930 to 1945. 

In the earlier period, there was no income tax law to influence the 

dividend policies of corporate managements. It 

' , , , , . , . , , Comparison with 

is probable that during that period a large per- . 

centage of corporate earnings were retained in 19 ™",JJVJ ^ ^Q, 

the business. It is also possible that there were 

many cases where earnings were retained merely to avoid such a large 

dividend in one year that stockholders would be disappointed in a 

later year. There may have been cases where the management delib- 


erately invested surplus funds in unrelated industries in order to 
stabilize earnings so that stockholders would not feel the full impact 
of a bad year in a particular industry. 

The timing element in connection with use of earnings for expan- 
sion has been referred to by other members of the panel. A very good 
example of this problem exists in the oil industry. A representative of 

^. . ', _ a corporation which could be described as a 

Timing Element for \ . 

small business enterprise, explained the problem 
Expansion: Impact on . x l r 

_., , , encountered by his company under Section 102. 

Oil Industry J c . \ J . 

A large part of its business is the exploration 

and development of new regions where there is a possibility of dis- 
covering oil reserves. Very often, nothing is known about a new oil 
field until it suddenly becomes a hot situation. This is something 
like the situation in the needle trade which one gentleman has de- 
scribed. The oil company cannot provide a reserve from the earnings 
of one year just in case such an opportunity comes up in the next 
year. If no such opportunity occurred, there would be no defense 
against Section 102 for the accumulation of surplus. 

This is a problem which faces a small business with few stock- 
holders and does not exist in the case of a large corporation with 
widely held stock. In the latter case, there would be more latitude in 
accumulating funds to invest in unknown future opportunities. Since 
there is obviously no motive to avoid surtaxes on any particular stock- 
holder, it would be difficult to say that the accumulation was un- 
reasonable. Moreover, the activities of the large corporation are spread 
over a wider field while the small corporation may be forced to con- 
centrate its activities in one spot at a time. 

This same problem exists in the chemical and drug industry. In the 
large enterprises, a research staff is constantly attempting to develop 

new products. Whenever they are successful, 
Chemical and Drug . .« , ,. / j • c 

there will be an expenditure for productive fa- 
cilities and an advertising campaign. Although 
the management may not be able to predict the discovery of a specific 
new product for which funds will be required, it can reasonably as- 
sume, based on prior experience, that there will be such products 
coming along every year. By contrast, a small enterprise in this field 
may have a new product every five or six years. It may be developed 
by someone working in his own laboratory who brings the results of 
his research to the corporation to be exploited. Under these circum- 
stances, the company cannot show that there is a constant investment 
of funds in new ventures. It would be very difficult to show that the 


accumulation was not motivated by a desire to save surtaxes, even 
though the entire accumulation in a particular year was needed five 
years later to launch a new product. 

I also suspect that Section 102 has played a large part in the sales 
of small business enterprises to larger corporations. If there are wind- 
fall earnings in a particular year, the stockholders are faced with the 

alternatives of receiving large dividends or sell- _ . 

P. • 1 • r™ Sales and Mergers of 

mg their stock and taking a capital gam. The _ „ _ 

,.% , , r , , ° , . Small Enterprises 
difference m taxes may be large and the business 

may be one where the stockholders are not optimistic as to future 

prospects. This may have been true in the textile industry during 

1946 and 1947. It would be interesting to see the results of a study of 

the industries which had unusually large profits during those two 

years. The extent to which there were mergers and sales of businesses 

within such an industry during that period might be compared with 

a period when earnings were at a moderate level. Such a study might 

support the theory that many small businesses become absorbed by 

big business because of the effect of Section 102. 

Discussion of Statement by Vincent H. Maloney 

Mr. George: Thank you for your information, Mr. Maloney. Any 

Mr. Mickey: I have a question. 

Mr. George: Yes, Mr. Mickey. 

Mr. Mickey: Your reference to an organization engaged in the 
production of products that might be in the nature of scientific dis- 
coveries — whether it is a great corporation or a small one — don't you 
think that some reasonable accumulation of surplus could be justi- 
fied on the ground that, being engaged in research it is natural to 
expect some results at some time, and buttress that by pointing to 
other companies engaged in scientific research which have expended 
sums necessary for advertising and production, etc.? Don't you think 
they would be sustained on that theory? 

Mr. Maloney: Yes, I do if the company is engaged in research. But 

take the example of the importer which I men- „'..■.•- 

Probably Causes 

tioned. If his company has $ko,ooo of profits, _ ■ . . 

, ,,..,, ., , Exploitations of New 

that amount must be distributed to avoid the _ , , , 
c ■, ^ T .» . . Products by Large 

Section 102 penalty tax. Next year, if there is an „ , ^. 

. r \ . J , Rather Than Small 

opportunity to exploit some new product or new , 

scientific discovery, the $50,000 is not available. 

The person who controls the new product must find a corpora- 


tion with enough funds to handle the project. This is more likely to 
be a large publicly held corporation which can retain funds to antici- 
pate such opportunities. 

Mr. Mickey: You're speaking there of a situation where the com- 
pany has not done the discovering itself, but might have the oppor- 
tunity to acquire the discovery. 

Mr. Moloney: Yes. 

Mr. S. A. Smith: But isn't that true of a great many small busi- 
nesses? It doesn't have to be in the scientific research field. In your 
example, the business is importing. Now when he finds something 
good, he wants to buy it and put it across before somebody else gets 
it. That applies to many products. Anyone who expects to bring out 
a new product will need money for its development. 

Mr. Cooper: Well, wouldn't you say that if a company is seeking 
other products, and actively looking for them, it is justified in re- 
taining some part of its surplus? 

Mr. Maloney: I was thinking of the situation where the owner of 
the product is looking for someone with capital to invest. 

Mr. Ayers: The question is not whether it is justified, the question 
is whether — 

Mr. Maloney: You mean justified under Section 102? 

Mr. Ayers: Yes, but that is a conclusion to be drawn after the 
event. What we are after, really, is whether or not because the owner 
thinks the law applies, he will not retain funds for that purpose. 

Mr. Maloney: In my illustration, I applied the same effect to the 
case of scientific discoveries which had been described to me in con- 
nection with oil discovery and development. The situation of an oil 
company which is vulnerable to Section 102 is a perfect example. It 
cannot hold the money and wait for something hot to develop next 

Mr. Cooper: I don't know. I should think that in view of the de- 
velopment of oil properties, the company has accumulated funds and 
is now looking for new fields to conquer. 

Mr. Maloney: That is a problem which may have different im- 
plications in different situations. What we want to settle is whether 
in this hypothetical case, the corporation would be subject to Section 
102 if it accumulates earnings without a specific objective. 

Mr. Austin: Don't forget that you are faced 
Influence or Fear . , , r _ , . 

with the fear problem again. 

Mr. Maloney: I feel as you do that if you were faced with the 

problem for a company after the event, you could make out a strong 


case. However, it is quite another thing to advise following a policy 
which may cause the Bureau to invoke the penalty. 

Mr. Cann: In that case you had a history of accumulation of non- 
business assets, and you had an absolute blank record, as far as any 
real showing, not alone as to commitment — that is, they hadn't even 
started to acquire or develop some other product. It was some vague 
testimony that their patents were going to run out, and I think they 
would be in the soup. They'd have to do something else. Well, they 
are still doing business at the same old stand. 

Mr. Ayers: Well, Mr. Maloney's reference to the case was not for 
the merits of the case, but rather for the precedent it establishes for 
minority stockholders, the complaint that there was no 102 case. 

Mr. Cooper: Well, when we think of the type of case here, we're 
thinking of the minority stockholders. 

Mr. Maloney: That's right. Mr. Austin, I think, got the point I 
meant to make, that regardless of the merits of the stockholders' action 

in that case, it seems that a minority stockhold- 

, . . ,. , r ,, , . ,. Directors Liability 

ers action immediately following the abdica- 
tion of Section 102 liability, would be practically a matter of course, 
if I know minority stockholders. 

Mr. Ayers: I don't think so. 

Mr. Cooper: I've often wondered, as an accountant, as to just 
how good that proposition is, as to whether they were responsible. 
They did not actually fight the liability. You have an entirely differ- 
ent situation if you have directors who are in a position where they 
are personally responsible, or rather personally vulnerable, if they do 
what they think is for the best interest of the corporation, and then 
things go wrong. 

Mr. Ayers: Oh, yes, there's no question about that. 

Mr. Cooper: In the case of the vulnerability of the directors, as 
far as the court is concerned, I think you would have a very different 
or rather difficult job, if you get a situation where the director has a 
few shares of stock or none at all. 

Mr. George: You mean, where it doesn't show personal advantage? 

Mr. Cooper: Well, personal advantage would indicate that they 
didn't act reasonably. Certainly where you are acting for your own 
benefit or have gone even beyond. 

Mr. George: Perhaps we'd better get on. 

Mr. Allan F. Ayers, Jr., is a member of the New York Bar. Mr. 
Ayers, may we hear from you. 


Statement by Allan F. Ayers, Jr. 
Hodges, Reavis, Pantaleoni & Downey, New York 

Mr. Ayers: I would like to start with a brief statement on policy. 
My primary objection to 102 as it now stands is its unpredictability 

and its almost fortuitous incidence with respect 
Unpredictability and . . _ . . . x 

_ ... to particular taxpayers. As to decided cases, we 

Fortuitous Incidence x .. *_ _ . r . 

can all pretty well agree that if we were on the 

bench trying the case we might have reached the same results the 

courts have, in most of the cases. I think we might disagree with a 

few of them. 

It's pretty hard for a decision to be so obviously wrong as to be 

totally unfair to either the government or the taxpayer, but it isn't 

the cases that get into court that to my mind create problems. It's the 

fortuitous incidence of the revenue agent hav- 
Court Cases Are Not . . , . . . 

in R raised the question on the examination. 
Measure or Effect , . _ ....... , 

Take these statistics in Professor Williamson s 

report, even assuming for a moment that they're not entirely com- 
plete. They're at least symbolic of the volume of cases that come up, 
and the dollar volume which is settled before it ever gets as far as 
the courts. 

There's a variation, it seems to me, between districts in that sense. 
For example, I know from personal experience of a district in which 

• . the agent in charge, and consequently the agents 
Variations in Agents' . . , , . f i_ • 

working under him, are very loath to raise 102 
Attitudes in Different . ° , } P . . 

questions, and you can go pretty far in that 

particular district without having any concern 
about the questions coming up on examination of the returns, but 
other districts, which I understand are much more severe, exist; so 
that there is no uniformity of application of the statute, due to the 
personality of the lower level administrators. 

I think that's wrong; I think the law should have a more pre- 
dictable standard than that for the benefit both of the practitioners 
and the taxpayers. One might say primarily the taxpayers because this 
fortuitous application is sometimes monetarily beneficial to the prac- 

There has already been some discussion of the 70 per cent rule 

which was enunciated publicly by the Treasury in 1946, but to my 

mind that 70 per cent rule is relatively insig- 
70% Rule ._ T j t 1 i- t 

nificant. I don t even know where it came from. 

Everybody was aware of it for many years prior to '46. The throwing 


of the rule into public domain, so to speak, added to the fear com- 
plex and that made the 70 per cent rule a matter of real prominence. 
I haven't tested the cases, but I doubt very much if there is any case 
in which the Tax Court or any of the appellate courts have been 
guided by the 70 per cent principle as an element in determination. 

So much for that. Now the next thing I think requires a little defi- 
nition on my part. As I understand, we are trying to evaluate almost 

a negative impact of a psychological fact. We 

1 u *» u a > \u t_ Effect in Cases That 

know whats happened in the cases that have 

, x . . , . . , , . Never Get to Court 

gotten as far as the mdicial reports, but the 

. --. - , J . r . T Important 

mam thing that we are trying to evaluate, I 

believe, is the effect on those cases that never get beyond our personal 

knowledge, and indeed the cases in which action is taken to avoid 

any incident in Section 102. 

I'd like to give three case histories, two in some detail, and the 

third just by a brief reference. First, a company, organized in 1920 

with very small capital, in the business of producing special machine 

tools. That company grew during the ten years 

r 1 1 r 1 Example of 102 

1920 to 1930 from a sales volume of about , 
<*,_ 1 * _, Influence on Business 

$75,000 to pretty close to $2,000,000. Between 

1930 and 1940, the sales volume increased to 

about $2,750,000, and during the war years, the sales volume was in 
excess of $3,500,000. It's now back to about a $3,000,000 level. The net 
cash assets of the company on the average exceeded the par value of 
the capital stock. 

The company has carried a very substantial cash or liquid surplus. 
By liquid, I mean in the form of government bonds. They have no 
outside investments and have periodically invested substantial amounts 
in increasing the plant as the sales volume of business increased. But 
it's gotten to a point now where beginning in about 1946 when they 
ended the war business, the foreseeable future of the particular ma- 
chinery which was constructed was somewhat limited as to future ex- 
pansion. The company has gotten the cream of the market as it stands 
today. The management, both operating and financial, is definitely 
of the opinion that a large reserve should be carried for this intangible 
depression which is pretty bound to come in their particular line of 
business. And that's a matter of management judgment. They can't 
prove that they'll have it, but the probability is that in a period of 
eighteen to twenty-four months, they will have to face a very sharp 
slump in sales. That in and of itself is not very serious, but in order 
for the company to continue to grow, the management for the last 


eight years has been carefully considering other related lines of busi- 
ness into which it might get, either by purchase or by beginning from 
scratch and building up a new business in the same way that they 
built up their past business. 

On that basis, they have restricted their dividend policy to a rather 
uniform rate over the past fifteen years, good years and bad years. In 
years in which they had losses, as back in the thirties, they still paid 
the same dividend which they paid during the early part of the 
thirties, and that same rate was continued throughout the war. 

Their excess profits tax problem was not severe because of the 
plowing back of earnings in the prior years, which are represented 
today by the cash and liquid assets and plant expansion. In 1946, the 
company came to me and said, "Are we safe if we continue the same 
rate of dividend?" Their dividend at that time, in dollars, amounted 
to the par value of the stock per year. That represented about 35 to 
40 per cent of the earnings in 1946. In 1947 it represented a slightly 
higher percentage. In 1948, which was ironically an extremely good 
year when it was expected to be the contrary, it represented about 
25 per cent of the earnings. I said, "You're taking a risk in each of 
the three years. Forty-six is past, the statute has run. Forty-seven is 
about to run. The question hasn't come up with the agent and '48 
is still open." Is the axe hanging over the head of this company or not? 

The stockholdings of the company are concentrated, a majority in 
the hands of three trustees who represent the estate of a former stock- 
holder, and the balance distributed nearly equally among about four 
unrelated family groups of stockholders. They were the initial back- 
ers of the enterprise. In the current year, their earnings again have 
been slightly more than was anticipated, and the problem now comes 
up in 1949: Can they get by with a 30 per cent distribution of earn- 
ings, having in mind the desirability of retaining a substantial cushion 
against this dim but reasonably foreseeable depression which will 
occur in their business? 

Or should they distribute more? The, shall we say, sophisticated, 
financial management of the company wants to retain any excess over 
the high rate of dividend. The unsophisticated element of the man- 
agement, which is primarily operation and sales, wants very definitely 
to increase the dividend. They're afraid of Section 102. 

Now I say afraid. I know that on the basis of personal interviews 

with the management. They don't know why 

they're afraid; I think they might have a pretty 

good case, and in any case, it's reasonably clear that their over-all pic- 


ture is such that they have an honest intent not to avoid the surtax, 
because the average group in the way the stock is held would not 
avoid any surtax over and above, say, the 28 per cent rate, if earnings 
in excess of $100,000 are retained. 

So there is no real intent to avoid the surtax in this situation. It's 
the fear element, and the ultimate issue will rest in the December 
dividend meeting as between the financial management which wants to 
proceed in its customary conservative style — that's the way the com- 
pany got where it is today — and the operating management which, 
almost without knowledge, is afraid of the consequences of Section 102. 

There is no question of directors' liability. One director is a trustee 
of the estate — of course you might have an objecting beneficiary but 
that's dubious — the other family stockholder groups have representa- 
tives on the board so that there can be no question of ultimate stock- 
holder criticism. It's a real case of Section 102 actually affecting the 
ultimate decision. Now, of course, when the decision is made this year, 
we can't say what other factors may have come into it. In one case 
there is an obvious desire to have more dividends by one of the direc- 
tors. It may be that the thing may work out as a compromise, but we 
can't say in this situation that 102 is not a representative at the 
table of the directors' meeting when they decide on their dividend 

The second case is, perhaps, a by-product of Section 102. It's the 

directors' liability problem. In this case a transportaion company 

which has a volume of business of over $100,000,000 has 30 per cent 

stock held by what we might call a predominant 

r^t. - 1 , Directors' Liability 

group. They were the entrepreneurs, the people 

who got the company together and put it where it is today. The bal- 
ance of the stock, roughly 70 per cent, is pretty widely scattered. It 
is listed on the Exchange. There are a majority of directors of the 
company whom we might consider independent from the predomi- 
nant group. 

Last year, when dividend time came up, there was some sentiment 
in one part of the board of directors, and this sentiment was divided 
between the representatives of the larger stockholders and the public 
representatives, for a reduction in the dividend. There were some 
reasons against that from the standpoint of stockholder relationship. 

There was no inclination on the part of any director, I believe, to 
increase the dividend except that one director, having knowledge of 
the Trico situation and the claim against the Trico directors and the 
ultimate settlement, raised the question as to his liability, if Section 


102 should be applied, against the company under the Trico princi- 
ple. Now, I think that's pretty remote to begin with, but the question 
came up and it then became a question that all the directors wanted 
to take into account. Were they running a risk? The ultimate de- 
cision was to retain the prior dividend rate and not to increase. 

Again I think that part of that is a policy decision. I think it can 
almost be said that a poll of directors on a basis of business policy 
alone and without regard to outside factors would have been to 

reduce the dividend. It turns out that that 
Effect on Dividend . . t . ... , . , 

would have been a wise thing to do, but that 

was a 1949 development, not 1948 knowledge. 
I don't know how we dissect the thinking of the board of directors at 
the meeting in which the action was taken. My recollection is that 
there were probably nine men present; it may have been eleven. 

In any case the decision was a matter of negotiation, discussion, 
and consideration by all parties after they had had the benefit of the 
accountant's opinion, legal opinion, and the opinion of the manage- 
ment of the company — the tax management of the company — as to 
the impact of Section 102, the risk the directors took, and the other 
elements of business policy that came in. Again I think Section 102, 
while to my own way of thinking it was a remote possibility and one 
that you could almost disregard, was an element which was present 
at the table when the directors set the dividend rate. 

The third case is the case of a large corporation with stock widely 
held. No stockholder owns more than 5 per cent of the outstanding 
voting stock, and I guess not more than 5 per cent of the outstand- 
ing preferred stock. That company does busi- 
Effect on Sale of 8 r .. . . , r ' 

ness generally in its own name, but in some cases 

it has subsidiaries. A couple of years ago it 
acquired a subsidiary in a deal similar to one that Mr. Cann was 
describing yesterday in which the stockholders clearly sold out to 
avoid a possible Section 102 liability. I don't think there's much 
question of that, it was a coordinate element with the profit element 
and possibly with the estate tax element. But certainly it was a factor 
on the initial sale. 

So there we get a small operation with some 102 incidence. But the 
other question which 102 affects directly, as far as I'm concerned, is 
a feeling among the management of the company, or some of the 
management of the company, that Section 102 might in some way 
be applied against the subsidiary of this widely held parent company. 

It seemed pretty remote to me under the regulations, but that is 


going to be a factor in the recommendations of the management to 

the board of directors as to how to vote the stock in connection with 

the administration of the subsidiary's affairs. „ .. 

ry,t • t ^t_- 1 i r 1 Consideration with 

There again I think that as a matter of law, 

probably the possible incidence of Section 102 e ° " S ' 

on the subsidiary is quite remote, but it is a real factor in the con- 
sideration of the management of the company as to the administra- 
tion of the affairs towards itself and its subsidiary, as between them- 
selves, not as it affects the general distribution of the dividends to 
the public stockholders. 

So I think that if these cases can be considered representative sam- 
ples, and they are the most prominent in my own experience, we can 
say that Section 102 has definite effect on the individual stockholder, 
whether it is applied or not. It is possible to say that Section 102, in 
the two cases I first described, was or will be an element in the fixing 
of a dividend rate which might not have been fixed at the same high 
level, had 102 not been present in the law. 

Now those are the cases; I hope the first case is one which will not 
get into the courts; the second case is clearly a situation which I think 
will never get into the courts. If that is the type of thing we are trying 
to evaluate then I think they are good samples of what happens, but 
again I think that it is very hard to take a collective decision by a 
number of men and attach particular units of weight to any given 
element in the ultimate joint conclusion of all participants in the 

Discussion of Statement by Allan F. Ayers, Jr. 

Mr. George: Thank you very much, Mr. Ayers. What do you 
think about those cases, gentlemen? 

Mr. Mickey: To what extent do you think that they illustrate an 
observation, that I think Mr. Piatt made yes- 
terday, that perhaps 102 was a good thing as 
it required an examination at the end of the Year - End Pos,tion 
year of the company's needs — that the Section does have a definite 
effect on the paying of dividends? 

Mr. Rudick: Well, you've already answered to a certain extent by 
saying that it is hard to evaluate that question. 

Mr. Ayers: Well, I would answer that in this way. This is a little 
bit of guesswork, too. 

In the first case I feel quite certain that the presence or absence of 
102 will not affect the examination of the corporation today, that is 


to say, in the first case some of the stock is employee-owned and the 
management definitely would like to pay out the largest possible 
dividend consistent with financial safety and providing for the growth 
of the company in the future. Now I know that management quite 
intimately and I think my estimate is sound when I say that 102 
has no effect on their examination of the affairs of the company. At 
present, with 102, yes, they may stretch a point and pay out an 
extra $5, $10 or $15 per share that they wouldn't have paid other- 
wise. Over the volume of shares, that is not a great deal of money 
but over a period of three or four years it amounts to a substantial 
part of the cushion they want to retain. 

In the second case, again, that is a well managed, well run company. 
I don't believe that the directors need Section 102 to compel them 
to look over the affairs of the company very carefully, not only in 
December, but, by George, every month when they have a meeting, 
they look at it and find out whether it's in good shape considering 
the business problems that are involved. I don't believe that 102 is an 
invisible conscience which is going to make a director scrutinize his 
affairs any more. 

Mr. Rudick: Isn't there a natural tendency on the part of the 

management of a publicly owned, or quasi-publicly owned company 

to conserve the assets against the proverbial 
Appraising Need of ^.^ ^ ^ then . f they haye ^ tQ rem[nd 

Reserve un t h em about it, they might sit down and more 

carefully appraise the future and see whether they really need all 
this reserve fund. 

Mr. Ayers: Well, with a publicly owned company, you've got other 
factors which are certainly of equal if not greater weight than Section 
102. You've got the necessity of paying dividends in order to main- 
tain your price level on the market. You've got your competition with 
other companies of the same kind. 

Generally speaking, as a matter of nontax law, of course, we will 
leave the internal administration of the company to the board of 
directors. The directors, certainly, in most companies today at least 
have a feeling of quasi-fiduciary obligation. They certainly have 
learned that in the legal profession by now, I think, and I think those 
elements are the things which really tend to push dividends out of 
publicly held companies. 

Now I agree that isn't necessarily true of closely held companies, 
but the way the smaller, closely held companies grew into large com- 


panies was by plowing their earnings back, not by distributing them. 

All we have to do for proof of the efficacy of that practice is to look at a 

stock like American Telephone and the statistics . 

1 Small Companies Grow 

which show capital appreciation ot that stock, . . . 

r . , ,, r by Retaining Earnings 

assuming that you exercised all 01 your rights 

beginning, let's say, in 1900 and continuing to 1949. I don't remember 

the exact figure, but I think it is something like $3,000 or $4,000 a 

share on that basis. Do you know about that, Mr. George? 

Mr. George: No, I'm afraid I don't. 

Mr. Rudick: Well, in the last decade they've paid out virtually 
all their earnings. 

Mr. Ayers: A lot of their borrowing, you see, is represented in 
new capital by way of conversion. 

Mr. Piatt: I was interested in your first case, particularly the fact 
that in 1946 and 1947 and 1948, the company, after due consideration 
of the risks under 102, went ahead and continued their regular divi- 
dend rate. And I would be almost willing to give odds they'll do the 
same thing in 1949. 

Mr. Ayers: I think they will. 

Mr. Piatt: My feelinsr is that while 102 sits mtM „ ., . _, 
, . ' , ,. , • 102 Considered, Then 

at their December directors meetinsr, he is al- 

... . ° Ignored 

most invariably outvoted. 

Mr. Ayers: I think that is true, and I think there is a certain ele- 
ment of "Section 102 be damned" in the attitude of the directors. 

Mr. George: Is that rather general? Could you report on that, 
you practitioners? 

Mr. S. A. Smith: That was simply true, it seems to me, in a lot of 
the letters I got, that they considered it very carefully, they set up 
the records to show why they kept their money, but the fact was they 
decided to take a chance on 102, and went ahead and kept the money. 

Mr. Rudick: I would say it was generally true except in cases 

where the directors are mortally afraid of per- „. ....... 

,,.,.,. Directors' Liability 

sonal liability. 

Mr. George: That's a pretty broad exception. You'd have to find 
out how mortal that terror is. 

Mr. Rudick: I think in a quasi-publicly owned company, there is 
a deep and substantial terror. 

Mr. George: I'm sure of it. I seize upon remarks like that in an ef- 
fort to find a focus if one exists. I don't really expect to find it. 

Mr. Cooper: There's a question of what you mean by generally. 
I would say in a great many cases that I know of, that's the situation. 


And there are others in which it isn't. To go back to the proposition, 

suppose it leads to action that perhaps shouldn't 

be taken in only 10 per cent of the cases, that's 
Only 10 Per Cent of , , T . ; r . . . 

too bad. Let s say, even m the other 40 per cent 

of the cases, there has been no problem, and in 

the other 50 there is a problem, but they say, the 

heck with it, anyway. 

Mr. Piatt: When you're talking percentages in this, it seems to me 
you must first consider the fact that — I assume this is correct, maybe 
it isn't — the major part of business, in dollars, is conducted by widely 
held corporations, and they're out of the picture anyway. So if you're 
talking percentages I should think you would first eliminate them, 
and then consider what percentage of the small closely held corpora- 
tions are affected by 102. I think your percentage on an over-all basis 
would be very, very small. 

Mr. S. A. Smith: Well your total over-all isn't conducted by widely 
held corporations to such a tremendous extent — I think it's only 60 
to 65 per cent, or 55 to 60 per cent. Isn't that right, Mr. Rudick? 

Mr. Rudick: I don't know. 

Mr. S. A. Smith: Well, C. E. D. made a study of that, as I remem- 
ber it. 8 

Mr. Cooper: It's not as big as everybody thought. 

Mr. S. A. Smith: The total volume of the small businesses of the 
country is somewhere around 40 per cent or 45 per cent, I think. 

Mr. George: Well, it depends on how you define small business. 

Mr. S. A. Smith: That's right; that's true. 

Mr. Ayers: I think Mr. Cooper's point is well taken. That is, if 
it affects even a relatively small percentage of the closely held com- 
panies adversely, or if it is an adverse influence 

Harmful, Even if Only . . . . . , r -, . 

in their management, it is a harmful situation 
ercentage s ^ ^ e faced ^.^ j j n back tQ the assunl p. 

Affected Adversely . . . r • 

tion that our economic theory is one of main- 
taining the growth and development this country has had through 
private, individual management of its business affairs during the past 
half century. If we continue that, I think we ought to leave these 

problems to the management. 
Companies Affected ^ Cooper . j think tOQ that that 1Q p er 

Adversely Would Be ^^ WQuld be the gmall cor p 0rate companies, 

Small Ones _ . 

not the large. 

8 A. D. H. Kaplan, Small Business: Its Place and Problems, Committee for Eco- 
nomic Development Research Study. New York: McGraw-Hill Book Company, 1948. 


Mr. S. A. Smith: I think that's true, but isn't there another factor 
as to why 102 is not quite so necessary to force the distribution? In a 
great many of these closely held companies, while it is true there are 
one or two dominant individuals, or several who are in the high 
brackets, almost always, especially after there's been a little distribu- 
tion of some of the original ownership stock, there are some poor stock- 
holders who want as much dividend as they can get. I know a lot of 
these companies that were started by one or two individuals, and one 
of them has died and the family has the stock. That's always con- 
sidered in the cases I know of. There is always a feeling that they 
ought to do something for these people if they can. 

Mr. Cann: I had a funny situation develop last year, in which the 
impetus or effect of 102 was reversed, but involved a corporation in 
which there were one or two fairly large stockholders. It's more or 
less of a family, or say several family propositions, but in total the 
great part of the stock was held in trust for a number of beneficiaries, 
all of whom ultimately received comparatively small amounts of in- 
come. And they, themselves, were not individually through these trusts 
in the high brackets, by any means, although you started with a fair 
bracket group even with the bonds. But the directors were very much 
concerned there about increasing dividends at this particular time. I 
won't bother with the details because I want to get at the basic prop- 

These individuals, had they received this larger income in that 

particular year, might have then started out on a program of living 

that would not be justified by future dividends, „ , _ .. 

. ,, . ,!.•!, !i * Concern for Small 

especially as an increased dividend would prob- „ , , , , 

.\ ; , . , _ r Stockholder 

ably mean that maybe they would have to get 

less dividends in the future. Now, there they were concerned, not 

about the high-bracket taxpayer, but the small-bracket taxpayer. 

Mr. S. A. Smith: Well, I think they get more consideration than 
most people think they do. 

Unidentified Speaker: I think they do. 

Mr. Cann: Allan, in your experience, in New York, would you 

say that the fear of the board of directors of the _ ,,.,,„ 

,,.,,,, . , r . Stockholders Suit 

publicly held company is not so much from the k m 
. ' , . . , , More Feared Than 

impact of the assertion of the 102 penalty, but <M , 

i_ i_ • T , • 102 Penalty 

that they are more concerned with the possi- 
bility of a stockholder's suit? 

Mr. Ayers: Based on my own sample, Norman, I would say that 
the latter was probably the case. I don't think that in the average 


publicly held company that you would have any problem at all, any- 
how. That is to say, that the directors of the larger widely distributed 
companies, where your stock concentration is small, don't have very 
much concern about 102, because it would be almost impossible to 
prove intent. At least they have been told so by counsel. I think your 
real problem is in these in-between situations where you have a closely 
held block of stock. Personally, I don't think 30 per cent would be 
enough to govern in that situation, but I do think your directors' 
liability is as great a problem, if not greater, than 102 itself. But that 
is an obvious consequence of 102, however. 

Mr. Miller: It seems to me they both figure, because certainly each 
director wants to avoid individual liability. But I think the other one 
is powerful; I think the average well run company is thinking in 
terms of the company, and they don't want the company to suffer any 
penalties like this, and they don't want to have the company run any 
serious risks, even if litigation starts. I think both of those operate, 
not merely one. 

Mr. Cann: I am inclined to agree with you, Mr. Miller. And 
while I said yesterday that the decision in the famous Buffalo case 
was a proper decision, on the facts, I remember very vividly the 
opinion of their counsel, and the opinion of a great many other com- 
petent lawyers, accountants, and practitioners that the government 
would not prevail in that case because of the fact that there was a 
substantial minority interest frequently traded in over the counter in 

Buffalo. So I sometimes think, Allan, even when 
Law Being Changed . . , .. , , . , - 

we look at our publicly held company that 
Through Court ... 1T r . . . , r c ' . 

while you and I agree on the kind of advice 

we would give the client, yet there is that power 
that Mr. Miller mentioned to me early this morning, as we were com- 
ing in, that rests in the hands of the government. The experience of 
all of us here is that new law is being made. 

Mr. Ayers: I think that is quite true. 

Mr. George: Since when? Do you mean a constant state of evolu- 

Mr. Cann: I mean those laws as interpreted by the courts as dis- 
tinguished from legislation that show that we are having changes 

Mr. Ayers: Well, Mr. Miller had an article 9 in the Tax Law 

9 Robert N. Miller, "Gifts of Income and of Property: What the Horst Case 
Decides," Tax Law Review, V (November, 1949), 1-5. 


Review which points that up in a different direction, but it is the same 
trend throughout the tax law. 

Mr. George: May I ask for some information. Is a stockholders' 
suit possible only after an adverse decision in the courts? 

Mr. Rudick: I would think so. 

Mr. George: Well then, this would be the question I was really 

after. Is there any record of stockholder suits? _ ,, ,, , _ . 
_ , ; r , , , , • r 1 Stockholders Suits 

That is, a record of stockholder suits after such 


Mr. Rudick: Well, the Trico case is the outstanding case. And 
when they settled it, the directors paid up. I think they paid up 

Mr. Dixon: Yes, that Trico case had some very unusual features, 
and I don't think that the average director, acting in good faith, need 
pay too much attention to that Trico decision. 

Mr. Silver son: Well, I found a surprising number of directors who 
had been misled by some of the writings on the subject into believing 
that if the company is held liable for 102 that they are automatically 
personally liable. 

Mr. Dixon: Which is very incorrect. 

Mr. Silverson: I think somebody could do a service by writing an 
article to set them straight. 

Mr. George: Well, your suggestion will go on the record of this 
meeting at any rate. 

Mr. Dixon: Well, there have been stockholders' suits trying to 
force larger disbursements of dividends. 

Unidentified Speaker: Well, that doesn't enter into it at all. 

Mr. George: Did the Trico case set a precedent? 

Mr. Cann: No, I don't think it set a precedent, but, as I recall it, 
it was the first case of a substantial company with a considerable 
group of minority stockholders. To that extent, Trico was probably 
a precedent-making case. 

Mr. Miller: Yes, and that was a well-fought case; it was fought 
in every way it could possibly have been. 

Mr. George: There hasn't been a flood of stockholders' suits since 
then? There haven't been similar cases? 

Mr. Cann: Well, the reason I asked Mr. Ayers the question, Mr. 
George, was that as I said before I wasn't present at the directors' 
meetings and I don't know what turn the discussion took with respect 
to 102, but when directors and officers of these publicly held com- 
panies ask you serious questions relating to their actions, in the light 


of 102, you have to conclude there is something back of these questions. 

Professor Williamson: Mr. George, may I, from the sidelines, in- 
quire more specifically whether the records of cases that have been 
brought into court which you lawyers know about — there have been 
quite a few cases decided since Trico — are those suits now on the way 
to litigation? 

Mr. Cann: I don't know of any. 

Mr. Silverson: There hasn't been another that I can recall since 

Mr. George: I think that is right except maybe in the case of some 
very small companies which you wouldn't hear about. 

Mr. Miller: And there is another reason why this field isn't cleared 

up by litigation as ordinary technical fields are. This thing was put 

in the law mainly as a threat, mainly as a compulsion and as a moral 

,„ , , . force and the Bureau is rather administering it 

102 Intended as . ' . . 5* 

that way. That is, it was put in there intending 

to scare management. You don't get the clearing 

up by court process in the case of a threat provision which you get 

otherwise. The questions are: Is it working well, administratively? Is 

the threat sufficiently efficient or is it too efficient in its reaction on the 

people affected? 

Mr. George: Well, what do you think about that outcome? Could 
it be any other way considering the kind of law that this is, the kind 
of tax that it is? 

Mr. Miller: I doubt it very much. 

Mr. Dixon: Before we get off this subject, Mr. George, there is 

one point that occurs to me in connection with this 70 per cent rule — 

no one seems to know just how it came about. I just wondered if 

Norman Cann can confirm my own recollection. It goes back a num- 

- . . , ber of years when the Bureau itself administra- 

Ongin of . _ ' . _ , . . , , , 

__ n ^ „ , tively reached this 70 per cent idea based, as I 

70 Per Cent Rule /. t . ' r , , 

recall the discussions at the time, on a survey of 

so-called public companies where they thought personal surtaxes were 
not too much of a factor, indicating that somewhere in the neighbor- 
hood of 66% per cent of earnings had been distributed over a period 
of time. As a result they then issued instructions to the agents, as a 
matter of audit procedure, that in any case where 70 per cent was 
not distributed they were required to make a report on whether 102 
should be applied or why it shouldn't be applied. Now, that is 
really the start of the 70 per cent. Whether that is still in effect, I 
don't know. Am I right on that, Norman? 


Mr. Cann: So far as I know the agents, in their transmittal letter, 
have a statement to that effect. 

Mr. Dixon: The original, as I remember it, was a mimeographed 
letter to agents, a confidential mimeograph to agents to look at it 
from the standpoint of 70 per cent. 

Mr. Cann: Well, in the revenue agent's Manual, Mr. Dixon, they 
have specific instructions on that. I couldn't say, as of today, what 
those instructions are because they are constantly changed, but the 
last I knew the instruction in the Manual was still there. 

Mr. Dixon: As of today, I saw a confidential report covering 1946, 
1947, and 1948, cleaning up all three years at once, and in that report 
they made a specific statement with respect to Section 102, so it ap- 
pears still to be required in the confidential report and that contains 
the 70 per cent clause. 

Mr. George: I like Mr. Ayers' first case the best because it raised 

again the question of imminence that, to my lay mind, has been 

assuming importance as one of the embarrassing 

01 , Imminence 

features of the tax, and one which I thought we 

could most usefully pass on to the other panel as needing a policy to 

cope with it. 

There is another point you made, Mr. Ayers, that I would like to 
ask you about. You spoke about the variation in the quality of the 
judgments by areas because of differences in the v ' • f h 

competence and personalities of revenue agents . 

and so forth. I suppose that there are lots of 
difficulties inherent in any type of national organization. Do you 
know of any cure for that? Or is it something that must just be taken 
as one of the facts of life? 

Mr. Ayers: No, I take it that it's pretty hard to cure it. We all 
recognize that administrative practices vary from point to point, de- 
pending on who is administering the particular law. But I think in 
this case the law itself, even with the decided cases we have had on 
the record, is not a clear and well-defined law, so that the fortuitous 
application by one agent or another has greater scope, you see. That 
is to say, if you're in an argument with an agent, you've got some 
cases on his side and you've got some cases on your side. He's also got 
a general policy which lays out certain requirements, but it's a very 
indistinct type of thing. You just can't be sure when you're going to 
face it and when you're not going to face it. 

Mr. George: Well, as I see it, it can only be cured by a much more 
definitive set of standards and regulations at headquarters by which 


everyone would be guided to limit the discretion of the agent and thus 

_ ,. . . limit the amount of fortuity that could occur. I 

More Definitive , . . . 

_ . j v, A A bring this out now, not to try to settle it but be- 
Standards Needed ° . . ... ' _ 

cause it seems that this is one of the general items 

with which we might close the discussion. 

Mr. Ayers: Well, if we gave the Commissioner more of the burden 

in making his assertion we might have more uniformity on the appli- 

-, , „ , cation in the field, I believe. That is to say, the 
Burden of Proof , . , , , , , , 7 ' 

burden is entirely on the stockholder of the 

corporation now to defeat the assertion by the government. 

Mr. George: All right, well that belongs to the point. If I may 
suggest so, we'll hold it for later consideration together with other 
major points with which we want to emerge. 

Now, Mr. Dixon, we have been holding you off a good while. 

Statement by Albert Dixon, Jr. 

Hadfield, Rothwell, Soule & Coates, Hartford 

Mr. Dixon: That is quite all right, sir. I may, perhaps, look a 

little bit differently on this than many of the previous speakers. I had 

better give you my experiences and background. I am a member of 

a Connecticut firm. We serve some 200 corporations, either located 

.... in Connecticut, or controlled by Connecticut 

Connecticut Light -i^ri • -r * 11 

r m ., capital. Of those corporations, I should say 80 

Manufacturing Family A . A *„ 

per cent will tall in your $1,000,000 to $0,000,000 

bracket and are of the light manufacturing type, 

that is, ball bearings, all types of screw machine products, small com- 
puters, typewriters, and things of that type, including some household 
appliances, but it's all of the small nature. I'm throwing out the large 
ones such as steel mills, etc., because I would like to confine my re- 
marks to that large group that fall between one and five million 
capital. Many of these are family corporations. The family corpora- 
tion and the older type of family corporation (I mean the second, 
third and fourth generation) are very prevalent in our area, and the 
ones, of course, you would expect to be the most vulnerable under 
Section 102. 

In going back, I find that from about 1936 on, because '36 is really 
when we first became concerned with 102, after the change in burden 
of proof which occurred in 1934, there were only two years in which 
there were made any particular distributions, having Section 102 as 
the primary motive in back of them, and that was in '39 and '40. 

During the war years, 102 was a dead issue as far as we were con- 


cerned. In 1946, 1947 and 1948, while earnings were extremely sub- 
stantial, the inflationary spiral required tre- 

, . . . . , . Experience or 

mendous investments in inventories and in re- 

• i_i j^i r ^ i. • 1 r j Connecticut Firms 

ceivables and took up most of the liquid funds 

of those corporations. We had cases of corporations that had always 
done their own financing and were in the neighborhood of a hundred 
years old, who were forced for the first time in their history to borrow, 
in spite of very large earnings. Now, that might be a situation pecu- 
liar to our part of the country. I don't know. 

In units, I don't think inventories are overloaded, but dollarwise, 
due to the extremely sharp increases in costs, it has required a tre- 
mendous investment of liquid funds to carry the inventories and the 
receivables at the present high level of demand, so that in '46, '47 
and '48 we had very, very few problems with Section 102. 

Now in '49, starting in February, orders fell off very rapidly. Back- 
logs were pretty well eaten up by June, and we had quite an unem- 
ployment situation. In September, they started to pick up. Things are 
rolling along very well at the present time, but corporate earnings 
are such that there is only one case where Section 102 even enters into 
the picture for the year '49. 

Now, it seemed to me as we've been discussing this that we have 

been emphasizing the very small percentage where Section 102 is a 

factor. If in a group of 200 corporations, closely 

u u j r ii j- • 1 Small Percentage of 

held, ana or small or medium size, you have 

i t is. a *. e c • Corporations Affected 

only a very slight effect from Section 102 over 

a period of fourteen years, then I think that is a very pertinent thing 

for us to consider. 

Now, it's true we have one case out of those 200 corporations where 

definite harm was done. That definite harm arose from the fact that, 

in the administration of Section 102, the courts 

.„ t ,. x , j mi Definite Harm in One 

will recognize only immediate needs and will 

,. r . Case Because of 

not give a corporation any credit for retention 

r -, „, Immediacy Doctrine 

ot earnings on long-range programs. That par- 
ticular case happened to be where the product had for many years 
been distributed through five main distributors. With all the eggs in 
those five baskets, tremendous pressure, almost dictation, commenced 
to come from the customers. The concern decided to go into a national 
advertising campaign and get an extremely wide distribution of its 
product, probably to, let's say eight hundred or a thousand customers 
instead of the five. 

The management thought that the advertising plan would probably 


require anywhere from a million and a half to two and a half million 
dollars. They attempted to retain profits, as against that plan. In 1938, 
they were caught on Section 102. It's a very closely held corporation, 
by the way, and runs around ten million in assets. 

They distributed around 55 per cent. The technical staff did rec- 
ognize the 70 per cent, and so we made a compromise on the basis 
of the income between the 55 per cent distribution and the 70 per 
cent so that the tax itself was rather painless. It did hurt them, there 
is no question about that, because in subsequent years, 1939 and 1940, 
they did make heavier distributions than they would have done had 
they not been caught on Section 102 in 1938. I think the decision 
was unfair but it was let ride because the dollars and cents involved 
were not particularly harmful and it was hardly worth while taking 
it all the way through to the Tax Court. 

But with 200 corporations for fourteen years (twenty-eight hundred 
tax returns) only six have actually been involved in challenges. That 
is a mighty small percentage. Out of those six challenges, three were 

abandoned by the revenue department, one was 

ontro mg c i osec j_ by t h e technical staff, therefore there was 

Factors in Dividend ...., , , ^ . „. • 1 -^u 

no judicial record, and two went to trial with 

l " """ one company being successful, and in one which 

in 1939 and 1940 *\ \ c 6 . . 

was an obvious Section 102 case, tne govern- 
ment prevailed. It is true that in each one of those cases, we do have 
a continuing scrutiny each year with respect to Section 102, but apart 
from 1939 and 1940, I don't know of a case where dividend distribu- 
tion has been based entirely on Section 102, or where Section 102 has 
really been a controlling factor in that dividend declaration. 

Now I could take some of these cases, that is, the unusual cases that 
we have and bring out some of the points that these gentlemen have. 
But to my mind, we're here to see what the impact on the economy 
is and to find out if there is any tremendous effect, rather than the 
minor effect applied to a very, very small percentage. 

I'd like to get one further point across, and that is that I do not 

know of a single case where a small corporation 
No Case Where Small ^^ been ^ tQ ^^ r ^ proportion> 

Corporate Couldn't ^ ^^ ^ q£ .^ eamingSj if h was in a proper 
Retain for Expansion reasonable expansion prog ram. We've had no 

trouble whatsoever on those. 

I think a great deal of this whole Section 102 problem, as has been 

pointed out, has arisen from a lack of understanding. I think there 


are a lot of tax practitioners who have not gone into the subject thor- 
oughly enough and who are, you mietfit say, al- . . . 

£ £ i £ - it Problem Arises from 

most more fearful of the consequences than the , , 

,. , * , iii Lack of Understanding 

management or directors, and they have had the 

tendency of still further spreading that fear. 

I think there is nothing to fear from Section 102, by any manage- 
ment or board who act in good faith, giving first consideration to the 
corporation's own problems, and merely taking 
a side glance at Section 102 after they've had " 9 to Fear: 

some good sound advice. I will say that in our Except,ons Few and 
area, decisions are made without regard to Sec- nimportant 

tion 102, and based upon true corporate requirements. Now I am 
not going to go into the individual cases that are the exceptions. To 
my mind they are too small in percentage, too small in number, and 
the dollars involved don't amount to peanuts alongside of the gen- 
eral economy. 

I do not favor abandoning Section 102. I think it is necessary to the 
tax pattern of the type of law we now have. I do believe there are 
three main things that might be done. First, 
if we could get something written into the law Permission for Lon 9 
that would permit long-range planning in good a " 9e anmng 

faith rather than the immediate need rule that the courts are now 
enforcing, that is a very important point. 

Second, I do think the Commissioner should take over the burden 
of proof as was required before 1934. This would prevent agents from 
holding out this threat. That threat is used 
more to get concessions on other items rather ur en Proof 

than on Section 102 itself, and by shifting the burden of proof back 
to the Commissioner I think we would get rid of that annoyance and 
that bad administrative practice. 

Third, there are many of these small corporations that do not carry 
perpetual inventories. They are too small and it would be too cum- 
bersome and too costly to have elaborate accounting. Therefore, they 
are not always sure in December just how they 
are going to stand. For this reason, I think they Credl * for Dividends 
might work into Section 102 credit for dividends P °' d After End ° f YeaP 
paid out of previous year's earnings shortly after the close of the year 
when the earnings are definitely determined. Take the guesswork out 
of the dividend decision in December. 

Now, if they do those three things, I don't think that any reason- 
ably operated corporation acting in good faith has anything to fear 


from Section 102. I think it is about time that someone wrote an 

article for the Journal of Accountancy or a Law Journal, entitled 

"Why Fear Section 102?" and see if we can't get 
Education of , , 

a more commonsense approach to it on the part 
Practitioners Needed _ . . . T , , 

of the average practitioner. In other words, we 

need more education among our own tax practitioners on this whole 

subject, so that they won't be accelerating the nebulous fear of the 


Mr. George: Mr. Dixon, to get your point clear before the dis- 
cussion begins, you made two or three suggestions. You said if they 
do these things there is nothing to fear in Section 102. For the sake 
of clarity, what would be your position if they don't do those things? 

Mr. Dixon: I still think there isn't a great deal to fear except that 
many long-range programs which would be very 

Beneficial Long Range benefidal tQ the economy will have to look to 

rograms 00 outside financing, rather than being taken care 

utsi e mancing ^ ^ v reta ined earnings as they have in the past. 

Mr. George: Then you think that if these things are not done, the 

biggest worry about 102 is the insistence on the immediate purpose 

for the funds, rather than long-term developments. 

Mr. Dixon: That's right. If they correct that one, I think we can 
get around the other two. That's the most important thing that I 
would like to stress. 

Discussion of Statement by Albert Dixon, Jr. 

Mr. George: Gentlemen, any comments? 

Mr. Cann: You made some reference to expanding companies, 
and I want to be sure that I understood you, Mr. Dixon. Would you 
say that a substantial percentage or normal percentage of your com- 
panies that you have represented are expanding companies? 

Mr. Dixon: I should say so. Let's take one company for instance 
which was established in 1923, with capital stock around $5,000. To- 
day, since 1923, that company has expanded to 

Expanding Companies & pQsition {n the neighborhood of $18,000,000 
Represented ^^ yalue ^ witn sales runnm g i n the neighbor- 

hood of $30,000,000. Not one penny of additional capital has been 
put into that corporation. 

It has always been able to retain sufficient of its earnings for a 
tremendous expansion. I happen to have at least ten cases of that 
type, one of which has gone from an investment of $1,000 in 1920, 
up to its present position with sales running in the neighborhood of 


$54,000,000 a year, without the investment of one additional penny 
of cash. 

Mr. Cann: Would it be a fair question to ask you, how much of 
that expansion occurred in the period of 1920 to 1930, and how much 
might be attributed to the increased war facilities for which they 
receive special amortization? 

Mr. Dixon: In one case, the larger one of the two, there was no 
war business whatsoever. None whatsoever. It happened to be a candy 
manufacturing outfit; and the other one, there was a large percentage 
of war business and practically no facilities on necessity certificates. 
They didn't go in for amortization facilities too much up my way. 
Connecticut executives, as a whole, are pretty independent persons. 

Mr. Cann: I have one other question. Have the majority of your 
companies long-established dividend policies? 

Mr. Dixon: Yes, and fairly even dividend policies. When you get 
into a closely held corporation and a third or fourth generation, and 
it so happens that the families concerned in many of the cases are 

rather prolific, you find that there is a group of „ . , „ ^. . , , 
,., r r J . r 1. r -i Fair, y Even D'v^end 

third or fourth generations 01 the family, com- 

mi c • ■.. -j Policies 

prising we 11 say twenty to twenty-five individ- 
uals, who look to those dividends for their basic incomes, so much 
so that in several cases, dividends are paid monthly in order to furnish 
a running income for those family members. In those cases, they do 
stick to a fairly even dividend rate, because the present head of the 
family doesn't want to be feeding a lot of extra dividends during good 
years into the hands of the family and get them up to a scale of 
living that they can't continue. 

Mr. Ayers: It's debatable whether that's a function of manage- 
ment, though. 

Mr. Dixon: That is absolutely true. 

Mr. Rudick: That's in cases of closely held corporations. 

Mr. Dixon: Well, when it is a family corporation you do run into 
those situations. 

Mr. Cann: Connecticut is possibly, or probably, in much better 
condition than the balance of New England. I was raised in that area 
and have gone back to many of the towns in Massachusetts that I 
knew as a boy. Many plants which used to be 
there are no longer there. Now, I recognize they 
have had a labor situation, they have had their 
local tax situation, and they have had a growth 
of absentee management in the case of small companies. Also, I 

Distribution Earnings 
Blamed for Decline of 
New England Industry 


recognize that the center of population has been moving west. But I 
have heard many, many times, in Boston, that another contributing 
factor was the distribution of earnings by these various New England 
companies to a degree that they should not have distributed. I would 
be interested in your observations in that respect, because I per- 
sonally feel that New England is somewhat different from the bal- 
ance of the nation with respect to the areas having expanding econo- 
mies, as distinguished from New England which unfortunately has 
not been an expanding economy. 

Mr. George: Would that kind of difference, in your mind call for 
a difference in the application of the law? 

Mr. Cann: I don't think that is practical, Mr. George. 

I always have to consider situations of this kind to clarify 102 in 
the instance of closely held companies. Let's just take such a business 
as a laundry. It probably starts out in rented quarters, a small busi- 
ness, and it grows. The natural aspiration of management is to grow 
and to build a plant and, of course, to put the most modern machinery 
in the plant. That obviously has to be a long-time planning operation 
from the viewpoint of small business. 

Now assuming that you begin to accumulate some of your profits, 
lots of businessmen don't like to go right out into immediate expan- 
sion; they like to feel that a substantial amount of equity capital goes 
into this expansion program as distinguished 
^ong ange ccumu 10 £ rQm b orrowe( j capital. Now I get the distinct 
Necessary for Small r , - ^ £ 

reaction from businessmen in that sort 01 a sit- 

xpansion uat i on t h at they fear 102, because they would 
like to accumulate a substantial amount of money in relation to their 
business. Naturally, they would invest it in what we commonly de- 
scribe as nonbusiness assets. That is a long-time planning situation 
and they are worried about being vulnerable to 102. 

Now, while I would agree with a great deal of what Mr. Dixon has 

said simply because of the type of industry they 
Connecticut Experience . * A • t • ^ u 

have in Connecticut, I just want to be sure 

whether it is the consensus of everyone here that 

that is typical of the whole United States. 

Mr. George: Well, you can't raise that type of a question too often 
to suit me nor, I think, the Institute. 

Mr. Dixon: Mr. Cann, of course, there is this angle to it. We 
cover a small enough field so that we can keep in very close touch — 
I think closer touch than the average practitioner normally does — and, 


while I don't want to give us too much credit for it, I think the good 

condition under Section 102 in our particular „ . . . , 

• n ■, iiii 1 Proper Advice from 

area has been influenced a great deal by the study _ 

,' 1.111 . -i Practitioner Essential 

and the proper advice that has been given with 

respect to it. That's why I do believe that the tax practitioner himself 

has a problem of educating some of his clients and giving more healthy 

advice to corporate executives to get away to a great extent from this 

fear complex that now exists and which is totally unnecessary. 

Mr. George: Mr. Dixon, what kind of advice would you give to 
fit the type of concern that has just been discussed by Mr. Cann? It 
was afflicted with geographic handicaps, I take it. 

Mr. Dixon: It might be in any area, as far as that is concerned 
if it's an expanding small business. Frankly, I would retain a very 
substantial portion of the earnings and fight it out. 

Mr. George: Yes, Mr. Smith. 

Mr. S. A. Smith: These companies have so far gone along be- 
cause they needed additional liquid capital, increasing inventories, 
and so on and they have been doing a large volume of business. If 
business shrinks and if they work off their inventories, that is going 
to be represented by increased cash, isn't it? 

Mr. Dixon: That's right. 

Mr. S. A. Smith: Now, aren't they going to be troubled in the 
period ahead by 102? 

Mr. Dixon: When they shrink back to a normal volume all of these 
corporations are going to find themselves in an extremely well-heeled 

Mr. S. A. Smith: Precisely. 

Mr. Dixon: Therefore, they will have a different balance sheet 
pattern from the standpoint of Section 102. 

Mr. S. A. Smith: That's right. 

Mr. Dixon: Now, the years in which they earned that income and 
retained it are then out of the picture for Section 102, because it has 
already been accumulated and was reasonably needed at the time of 
accumulation. So they can't go back on that. 

Mr. S. A. Smith: No, they can keep that so long as they pay out 
their new dividends. 

Mr. Dixon: Yes, you have a new problem. In other words, each 

time you have a shift in the economic cycle you maM m , , 

, \ ,. . - -,'.- ,, . / ; 102 Problems Change 

have a distinctly different problem with respect 

c . ,, , , r • j 1 with Business Cycle 

to Section 102. Now we had one case of a widely 

held corporation, a wide public holding. There isn't a stockholder 


there who holds over 5 per cent. During the twenties, they accumu- 
lated a nest egg of about $5,000,000 in governments, and they sat on 
that nest egg year after year prior to the war. 

There was no reason for it other than an out-and-out reserve for 
contingencies. Regardless of the fact that they were a publicly held 
corporation, they made sure from '36 on that they were distributing 
pretty well up to the hilt on their earnings, because there was no 
excuse for the retention of earnings there, even though you had a 
large group of stockholders, none of whom held over 5 per cent. 

The war comes along. They go right through the war with their 
$5,000,000. Then, they happen to be in household appliances. Do you 
remember the terrific demand? Do you remember how they all started 
to manufacture in an unheard of way and get warehouse facilities and 
fill them to bulging with refrigerators and stoves and toasters and 
whatnots? Their $5,000,000 went into inventory together with $3,000,- 
000 of bank loans. 

Section 102 is dead as a dodo, as far as that company is concerned. 
So that each time you have one of these economic changes, your pic- 
ture changes. You can't always say, we're all right on Section 102 and 
know you're going to be all right in the next two or three years. You 
can't do that. It's got to be looked at consistently each year, and then 
get the management acting in good faith on it. If we can get away 
from this immediate need rule so that we can get in an element of 
long-range planning — 

Mr. George: That's all right. We agree on that. 

Mr. Dixon: Now, don't forget this too, and I think this is some- 
thing that is omitted in a lot of this discussion. You have your cases 
where, on analysis, you will often find that a great part of the work- 
ing capital of a corporation has been provided for by depreciation 
funds. Take a balance sheet and attempt to eliminate out of the quick 
assets an amount equal to the depreciation of their physical assets 
and usually you will find that most of your operating capital is your 
depreciation fund. 

Now, it has been recognized in one Section 102 case that I know 
of, that you should be permitted to fund depreciation for the purpose 
of replacing your plant when it wears out. Now 
eprea ^ raised an additional point before the Con- 

trollers Institute in February. If they recognize the principle of fund- 
ing depreciation, why don't they recognize the retention of additional 
funds which are necessary for replacement at the higher values today? 

I am speaking now of actual funds. If a concern does actually fund 


its depreciation, when it comes to any particular depression period it 
can always temporarily borrow, to carry itself through that period, 
from its depreciation fund. That is why I am not too concerned with 
these unreasonable — and they are unreasonable — accumulations for 
future depressions. That is, they are unreasonable when you come to 
analyze what the management has had in mind. They are going too far. 

Mr. George: You are assessing the question of degree which, of 
course, is always important. 

Mr. Dixon: That's right. 

Mr. Piatt: I wonder if, Mr. Chairman, we oughtn't to define a 

little more carefully, or ask Mr. Dixon to define, what he means by 

an amendment which would take into account 

Amendment to Permit 

long-range planning. To the extent plans are Ung . Range pianni[lg 
directed towards a long-range expansion pro- 
gram, the physical needs of the company, as long as the record is clear, 
you're in pretty good shape. I take it that what he is thinking of 
is more in the nature of reserves for contingencies. 

Mr. Dixon: No, by long-range planning I mean this. As the law 
reads now, you can retain for the reasonable needs of the business. 
The courts have said that if those needs are of a concrete nature, and 
immediate, then we will allow the retention. 

Supposing a concern has in mind that its present quarters are in- 
adequate and wants to go into an expansion program. Supposing it 
can set aside out of earnings a half-million dollars a year. The type 
of plant that it intends to make for its future quarters, which would 
be adequate, might run, we'll say to $3,000,000. 

So they formulate a policy of retaining a half-million dollars of 
their earnings each year for the next six years, without going into the 
actual purchase of the land or getting architect's drawings, or what 
have you, say until the fourth year, when they'll know more of what 
building conditions and costs will prevail at that time. It seems to 
me that a plan of that type, entered into in good faith by the direc- 
tors, not as window dressing, is a good sound business policy and 
should be recognized as such. 

Mr. George: I think the question there is, what will the Bureau 
actually do? What actually is the law? 

Mr. Rudick: Well, the courts, I think, would recognize it, but I 
am not so sure that the Bureau would recognize it completely, be- 
cause then the statute of limitations runs out on the earlier years, 
and so if they don't get in their oar at the beginning they are out 


Mr. George: So we have a technical consideration there which in- 
terferes with the logical application of the law. 

Mr. Rudick: That's right. Now, I think that the Treasury could 
well afford to give a longer period in which to make use of these 
accumulated funds if you had a longer statute of limitations. But I 
don't think taxpayers generally want a longer statute of limitations. 

Mr. George: You think they would rather endure Section 102? 

Mr. Rudick: I am inclined to think so. Now one other point that 

Mr. Dixon made was shifting the burden of proof. I am inclined to- 

_ . r n r wards shifting the burden of proof at least in 
Burden of Proof , & *■■,.,, . 

most cases, but the more I think about it, the 

more concerned I am about it. I think it is not an unmixed blessing. 

If the burden of proof is shifted to the government, the government 
counsel is going to go into these questions much more thoroughly and 
they are going to unearth a lot of skeletons in corporate closets which 
the management doesn't want unearthed. So I am not so sure man- 
agement would be happy with such a provision even though it is 
asking for it. 

Mr. George: It's lucky this finally came out, isn't it? 

Mr. Sibley: There is another point in spite of what Mr. Dixon 
says, based on his experience, which occurs to me from our experience. 
That is, we are currently reserving for losses due to devaluation of 

W1 , „ „,. , foreign currencies. Those losses have not been 

Need of Bhnd . _ ? ' . . , , 

_ . „ . infinitesimal by any manner of means and yet, 

Contingency Fund . ' ' , , , ' 

say three years ago, except perhaps by the econo- 
mists they would not have been retained by the average management. 
Now we have those reserves and we hope that they will prove ade- 
quate. If we had had a sort of blind contingency fund it would have 
turned out to be very useful. 

Mr. Dixon: If your reserves are justified you shouldn't have any 
trouble with the Bureau if they are set up in good faith. If you set 
them up too high surely the internal revenue agent can use hindsight 
and see that they have been too high, but if the action was based on 
what was a good, sound business decision at the time, I don't think 
he has a leg to stand on. 

Mr. Sibley: My point was a little bit different; that was that you 
might in one or two years have failed to have appraised your risks 
sufficiently and not have set up reserves the previous year. 

Mr. Dixon: Well, then, of course, you have the opportunity of 
setting up more substantial reserves. 

Mr. Sibley: But if you had set up a contingency fund earmarked 


for contingencies you would not have to hit for only one particular 
year for those reserves. 

Mr. Dixon: Of course, the trouble with that is if you open the 
door for unknown contingencies, which quite a few managements 
like, they would just simply go to town on them. Possibi|ities of Abuse 
They wouldn't use proper judgment. In other ^ B||nd Contjngency 
words, there is a dumping ground where they 
can throw in and retain some earnings and they 
abuse it. That's the trouble, and you can't open the door to that sort 
of thing without abuse. 

Mr. George: Well, gentlemen, you have uncovered a void there 
that has been troubling me for a great while. I have had a great deal 
of sympathy as this discussion developed for this question of im- 
mediacy and the problem it poses for the aver- _ . , , ,. 

; \ L . Question of Immediacy 

age corporation that knows that sometime it 

wants to do something, wants to forge ahead, wants to expand. It 
hasn't got any immediate plans. I can remember the case that was 
cited yesterday of the man who saw the market drying up for his 
product, and he was looking around for another one. He wanted to 
be right before he made his plunge. What is he going to say to the 
Bureau of Internal Revenue and what are they going to say back to 
him? Now, I have sympathy for the position of that man. It could 
be entirely authentic. Yet if a general principle of that sort were 
adopted the Bureau of Internal Revenue would be put in an im- 
possible position, as every man- jack would come forward with the 
same story. Frankly, I see no answer. 

Mr. Piatt: It is a question of the proof of good faith. If you come 
into the year of examination or get into the Tax Court and nothing 
has happened, then you are probably in the soup. 

Mr. George: With the kind of situation that I am envisaging here, 
two years or three years would have very little bearing. One kind of 
evidence that I thought at one time might have a bearing would be 
the record of the corporation over a long period of time. What did 
it do with its money? Did it have periods of accumulation? Did it 
finally use it for disbursement or for investment or for what? 

Mr. Dixon: The situation usually arises in a corporation which 
hasn't got the background experience to show. 

Mr. George: Well, that would normally be a small, young corpo- 
ration and wouldn't that be less likely to draw lightning than most 
of those which we have discussed here? 

Mr. Sibley: Yes, but not necessarily a small corporation. I can give 


you some more experience on that. In Brazil, Argentina, Cuba, and 
Mexico we started out renting warehouses and sales office facilities and 
tried to find out whether we had a market down there which would 
justify an investment in land, buildings, and so forth of a substantial 
amount. We found we did have it and a very real one at that, and 
subsequently we have invested several millions of dollars in land and 
buildings in those countries I have named. Had we not been in a lush 
period of earnings it would have been impossible except through 
extensive borrowings. I may add that we had endeavored to foresee 
when we began to get the feeling of those markets that we were 
going to reach that point. 

Mr. Dixon: You had taken a definite step by at least renting ware- 
houses and proceeding in good faith. 

Mr. George: Would you care to speak, Mr. Silverson. 

Statement by Harry Silverson 
Silverson & Allison, New York 

Mr. Silverson: My experience with 102 has been radically different 
from that of Mr. Dixon and I dare say from that of many of the 
other gentlemen here. I have never been associated with the large 
firms that are called upon at the end of the year to look at two, three, 
four, or five hundred situations and decide prenatally how much, if 
any, dividends to distribute in the light of 102. 

My experience has been weighted in a different direction. True, a 
certain number of corporations do call for my advice before the end 
of their fiscal year as to dividend policy in the light of 102. But at 
least of equal importance have been the cases that come along after 
a revenue agent has asserted Section 102, and the taking of the 
necessary steps from there on up to the Tax Court, if necessary. 

A third vantage point has been by indirection. You get a case in- 
volving the valuation of stock of a closely held corporation for estate 
tax purposes and, of course, one of the factors is dividend policy. 
That, in turn, brings you around to asking questions as to how valid 
the meager dividend policy was and why the policy was as meager or 
as liberal as it was. It might also come up in a salary case or in a 
Section 115-G case. 

_.„ . My first conclusion from these exposures to 

Sharp Differences in , , . .... , , 

. . the problem is similar to one noted here fre- 

Taxpayer Action, x — : 

AI . quently, namely that there are sharp differences 
Depending on Advice \. ' _ _ J . L . ., _ 

01 approach by various taxpayers similarly sit- 
uated, depending on the advice they get. 


I don't think, however, that we can dismiss that situation by saying 
that wrong advice is given to taxpayers and perhaps their counsel are 

too fearful of 102. That is a fact of life we have „ . - . 

r^, .,, -. , . , t Can * Dismiss 

to accept. That will always be with us when we _. . . _ . 

. r c a n Situation by Saying 

think in terms or 102. Some firms are naturally ... , ... 

.... , Advice Is Wrong 

more conservative than others in giving tax ad- 
vice and much more conservatism will also be reflected in their ap- 
proach to dividend distributions. They may hesitate to put in writing, 
or to state orally, that they don't believe the dividend need exceed 
x dollars lest an examining agent set up Section 102. 

The second point Mr. Ayers brought up to some extent, namely, 
the geographical differences in administration. I will go further than 
that. I contend that there is a shocking difference of administration 
within a particular office, varying from agent to 

asrent. There are some agents who will set up , . , . . . 
° . - /of Administration 

102 and others who won t even think about it, .... , . _ _„. 

, _. . _ Within Same Office 

given the same taxpayer. I am always disturbed 

in this connection when I come across, one of these estate tax valua- 
tions to which I referred to see a company which year after year after 
year either distributes no dividends or very nominal dividends and 
has never had to contend with an assertion of 102, and then recall 
other corporations with a much better dividend policy under all the 
circumstances which are plagued by assertions of undervaluations. 

Furthermore, once an agent has set up 102, my experience has been 
that unless you go to conference and have the thing killed completely 
you are fair game for every agent who comes in thereafter. It's a 
human tendency and I am not saying this critically, but it requires 
intestinal fortitude that very few people have. 

An agent, say, sets up 102 for 1945 and your case is pending in 

conference. In the meantime agents come in to examine for 1946 and 

1947. In no time flat you have 102 set up unless you can hold them 

off from closing these years until you have disposed of 1945. And 

then, in conference, if you don't convince the conferee or staff to kill 

102 entirely, you have to reckon with the fact „ . ,, . 

. r . i r i • i Corporations Hesitate 

that year after year you are going to be laced with _. . - 

* . ; ; & 5 . _ to Take Case to Court 

102. Furthermore, once you s:et into conference, „ , » .. 

..... y r . , Because of Revealing 

you may be faced with a situation where you « ,. . . . 

7 , ,/ r , , Confidential 

can t dispose of other items because you can t , , 

A . . . . Information 
reach a settlement on 102. Another point that 

hasn't been mentioned is that when a corporation takes its case to the 

Tax Court it may be revealing confidential information to competi- 


tors. I'm sure we have all, at one time or another, been told to make 
the best settlement possible because of this factor. 

In at least two cases the client said "If I have to pay out the whole, 
under Section 102, I would rather pay it than let my competitors be 
in a position to get information from me that I wouldn't give them." 

Because of these reasons I feel that it might be desirable if there 

were a quasi-centralization of the administration of Section 102. That 

^ . .. j is* where a local agent sets up Section 102 that 

More Centralized _ _ ?,,,,. 

., . . . .... part 01 the case should be divorced from any 

Administration Might , ,. , , T1T , . 

_ _ . , , other disputes and be sent to Washington to a 

Be Desirable . , • , ,. , - , . , ~ , 
special section dealing exclusively with 102. Only 

if that section, after conference where requested, approves the agent's 

action should the case go forward on 102. If we limited that procedure 

to cases where the agent has proposed 102 I do not think that the 

volume of work transferred to Washington would be such as to cause 

any concern. 

The next item to which I would like to call attention is the fact 

that if a taxpayer is held liable under 102 it makes no difference that 

, . - a ■ 1 ne reasonably accumulated some of his earnings 

Apply Tax Only to 7 5 

ana unreasonably accumulated only a portion. 

, . The tax applies to the entire earnings for the 

Accumulation , . , , , ■, , 

year — which doesn t make too much sense. It 

seems to me that if the law were amended (a) to provide that the tax 

applies only to that portion of the current year's earnings which is 

unreasonably accumulated, and (b) to increase the surtax rates on 

that portion there might be an incentive to many taxpayers to pay 

larger dividends than they are paying now. 

Mr. Rudick has mentioned the fact that 102 has been a deterrent 

to the use of corporation funds for investment in securities, thereby 

reducing available risk capital. It has also been a deterrent to corpora- 

-..-.. tions which have made the investment to sell 

Capital Gains _ . . . _ a _ , , 

_ _ their securities. We have the incongruous situa- 

Discrimmation in Form . ■ ° . , . 

, ',.. tion of a personal holding company, which is 

of Personal Holding / r ° r J . 

the black sheep of the corporate family, being 

permitted to take long-term capital gains with- 
out any penalty tax, whereas an ordinary operating company which 
happens to have capital gains cannot cash in on those gains without, 
possibly, running into Section 102. That doesn't make any sense. If 
an operating company isn't permitted to do it a personal holding 
company shouldn't be permitted to do it, or vice versa. 


Discussion of Statement by Harry Silverson 

Mr. George: Any comments? 

Mr. Rudick: One comment with respect to allowing a deduction 
for the amount of the dividends actually distributed. Now, there 

again, as in the case of the other proposals, I ^ . . . _. . . . 

,.,,■. . , , , . V. Deduction of Dividends 

think that is not an unmixed blessing. For one „ „. ., 

, . , , . r 1 n. i .,. Actually Distributed 

thing you then substitute for the test of liability, 

not the reason behind the nondistribution, but whether the accumu- 
lation is reasonable or unreasonable. That is the British standard, by 
the way. At least it used to be before, as Mr. Cooper pointed out 
yesterday, they put a tax on distributed profits. 

Now, if you do adopt that standard, I think that the courts, when 
they get cases, are likely to be less sympathetic towards the taxpayer 
because they know he gets the credit for what has actually been dis- 
tributed. And if they think, in their judgment, that the accumula- 
tion is unreasonable, regardless of the motive behind the accumula- 
tion, the government might win many more cases than it does now. 

Mr. Silverson: I don't follow that, Harry. He gets the credit today 
for what he distributes. Are you referring to the suggestion that no 
tax be imposed on that portion of the undistributed earnings? 

Mr. Rudick: What I meant was the portion that would have been 
reasonably accumulated rather than the portion unreasonably ac- 

Mr. Silverson: My feeling from the reading of the cases is that the 
courts have not addressed themselves to the amount of tax involved. 
They just go along in a void as far as that feature is concerned. I 
haven't noticed any detectable influence. 

Mr. Rudick: No, but suppose we are faced with a situation where 
they thought it was unreasonable to accumulate $1,000,000, but it 
was reasonable to accumulate $800,000. Under the present system they 
would probably decide the case in favor of the taxpayer and not sub- 
ject him to any liability, but with your proposal they might subject 
him to a tax on $200,000. 

Mr. Miller: Isn't one aspect of this that what we are dealing with 

here is in the nature of a penalty? Whenever you have a penalty the 

question is "does it fit the crime?" and if it's a penalty that doesn't 

fit the crime why it ought to be changed. My „ .';.... 
. / & . , " , Penalty Should Fit 

sympathy is with your suggestion along those . 

lines. I think the crime is the excessive accumu- 
lation and the penalty oughtn't to be bigger by the fortuitous cir- 


cumstance. Of course, it is true that in the days when they used to 
hang people for stealing shillings it was hard sometimes to get a 
conviction but I would put as much weight on that as on this other 
thing as to whether the penalty is appropriate or not. 

Mr. Rudick: Won't you be substituting the court's conclusion as 
to what is unreasonable for the directors' conclusions as to what is 

Mr. Miller: The whole thing does that. 

Mr. Rudick: Well, not in theory. The theory now is that the test 
is supposed to be intent, and if you didn't intend to save your share- 
holders from surtax, regardless of whether the accumulation is reason- 
able or unreasonable, you are not supposed to be taxed. 

Mr. Moloney: Hasn't that become somewhat of a metaphysical 

difference in actual working out? Doesn't our 
Is It Test of , . . ° , . , 

law work out as though it read the way the 
Reasonableness or ,,..,-, , . -> T , • • -i 

British law is doing? Isn t it primarily a ques- 
of Intent? . „ . . '~ . 

tion 01 whether your accumulation is reason- 
able or unreasonable, rather than this elusive intent? 

Mr. George: It is a nice point. Have you any general opinion 
about that as to whether in administration and judicial practice the 
test of reasonableness or of intent is likely to be paramount? 

Mr. Moloney: Some publicly held companies have been worried 
about whether their accumulation could be justified as reasonable, 
but there hasn't been any case brought or threatened, as far as I 
know, of any publicly held company which, let us say, looks unreason- 
Mr. George: The intent was the ruling consideration? 
Mr. Moloney: Well, it seems to me that in the mind of the 
Bureau, the intent is never there unless there are shareholders who 
suffer by the distribution. But the taxpayers, I think, a good many 
of them, feel that unless they have a record to justify the amount 
that they haven't distributed they might be subject to attack because 
the statute says that if there is an unreasonable accumulation there is 
a presumption that it was made to save surtax. 

Mr. Cooper: I think that most of the Bureau's administration has 

been purely on the question of the reasonableness or unreasonableness 

of the retention of earnings, and very little attention paid to the intent. 

Mr. Miller: After all as intent is a very hard thing to prove you 

have to judge it by its reasonableness. 

Mr. Cooper: Going back to Mr. Silverson's thought, I have thought 
of this proposition of a change that might provide for taxing only the 


unreasonable portion. Of all the figures I have ever seen I have never 

seen a case where there was any basis for argu- _ ^ , 

1 • r *. .. . t , Tax Only on 

mg that retention 01 $100,000 was all right but 

11 * . t -r ■, , 1 . -, , Unreasonable 

the other 1 100,000 wasn t, and I don t think the A , . 

, . _ , , , Accumulation 

way it is working today that you would ever 

have a case in which the courts would decide to tax just part of your 

accumulation because it is unreasonable. Remember this all goes back 

to unreasonable accumulation of surplus; not necessarily the taxable 

year. Now I doubt if you would have any case, and it certainly would 

be a most unusual one in which, for example, the first year you have 

a surplus they would hold it unreasonably accumulated. You usually 

find these cases arise when you have surpluses accumulated over a 

long period of years and now you are adding to it. I can't visualize 

the kind of a case in which, with that background, you would be 

able to say that x dollars was reasonably accumulated and x dollars 

wasn't. I think they would look at the whole picture and say the 

whole thing is reasonable or none of it. 

On top of that you have a difficult enough situation now determin- 
ing whether it is a fact that there is unreasonable accumulation. It 
would be a darn sight harder to determine or to face a situation in 
which the courts could come in and say, well, only x dollars is un- 
reasonably accumulated, the balance is all right. 

And I think you'd certainly face the situation Mr. Rudick has 
mentioned. There would be a far greater tendency on the part of the 
courts to try to draw a line where I think now they only hold the 
taxpayer subject to 102 where there is a real bad case for the whole 
accumulation, not for only part of it. 

Mr. Silverson: Well, let's take this situation: In 1946, and I be- 
lieve in 1947, the publicly held textile companies distributed no 
more on the average than between 25 and 30 per cent — I think that's 
correct — of their earnings. 

Now, it seems to me that if it were demonstrated to the Tax Court 
in a case involving a closely held corporation in the same industry 
that the publicly held companies distributed only approximately 30 
per cent of their earnings because, based on a history going back many 
years, they reasonably felt that they were in an industry that had 
sharp ups and downs and they ought not to pay out more than 
30 per cent of their earnings, the closely held taxpayer might win 
his case. 

Mr. Cooper: Now, in many cases these undistributed earnings 
aren't there to distribute anyhow; they are in higher inventories and 


higher values for the same quantities, and actually you don't have 
the cash in the bank to distribute. 

Mr. Silver son: I'm assuming you have it in cash or the equivalent. 

. «. „ Mr. Cooper: There is where I am getting at 

Large and Small f . 00 

the proposition. Your larger corporations are m 
Corporations in x . L . . . , J 

Dff P r an entirel y different position from your smaller 

corporations in that respect. 
Mr. Silverson: I am talking about some fairly large textile com- 
panies, privately owned. 

Mr. Cooper: I don't care whether they are publicly owned or 
privately owned. Take the large against the small. 

Mr. Silverson: I am only trying to indicate what the suggested 
change in the law would be. We have some very large textile com- 
panies privately owned and they are in a very bad position with 
respect to 102, or possibly are, under the existing law. 

Mr. Rudick: Well, are they if they distribute as much as their 
competitors do? 

Mr. Silverson: I think they are. You try and have a conferee throw 
a case out because the publicly held company was distributing only 
30 per cent. I don't think you would get very far. 

Mr. Maloney: No, he would say, "I don't know anything about 
their plans for expansion or capital improvements." 

Mr. Cann: It is my experience that the average field conferee 

would reason that, generally, in the instance of a publicly owned 

corporation, the amount of dividends declared 

„ , . , would be free from the influence of the result- 
Company as Yardstick . , , , , 

ing income tax consequences to its stockholders; 

whereas, in the case of a closely held corporation, the conferee in- 
variably assumes that the resulting income tax impact to its stock- 
holders determines the dividend policy. 

Mr. Rudick: Well, go beyond the conferee. Suppose you were a 
judge and everything else being equal, you were satisfied that the 
closely held company distributed as much as its competitors did and 
was motivated by what they did. 

Mr. Cann: If the issue should reach the courts, I believe due 
weight would there be given to a dividend policy that compared favor- 
ably with competitors, although this factor alone might not necessarily 
be a complete answer. Assuming, however, that ultimately the 102 
issue is resolved in favor of the taxpayer, great harm frequently occurs 
through its assertion. For example, let us assume that the penalty tax 
has been asserted for the year 1946 and that year is docketed before 


the Tax Court. The internal revenue agent in charge having the years 
1947 and 1948 for examination must necessarily comply with the 
audit program. Therefore, assuming the facts for these years to be 
comparable to 1946, it is quite likely that some action will be taken 
for those years unless the agent in charge can be persuaded to place 
the returns in a suspense file conditioned upon consents being filed 
extending the statute of limitations, which in itself is objectionable. 

More than likely the returns would be examined and Section 102 
asserted for 1947 and 1948 inasmuch as the decision for 1946 would 
not be handed down for two or three years. The taxpayer corporation 
is confronted, once the 102 issue is raised, with a substantial con- 
tingent liability which appears in its financial statements. The con- 
sequences are that the judgment of management is impaired and 
handicapped, not only with respect to everyday business decisions, but 
also future dividend policies, so long as this matter is pending. 

I would point out further that even if the examination of subse- 
quent years is postponed awaiting ultimate decision by the courts, the 
contingent liability is still present, adversely affecting business de- 
cisions, even though the ultimate answer may be favorable. 

Mr. Cooper: There is one thing that might be carried through on 

Mr. Silverson's thought, and it has been suggested in other quarters, 

and that is that there be an amendment to take „ ,. , 1H . . , , 

...... , . , . Credit for Dividends 

into account any tax liability that miffht arise „ . . . , m , , „ 

_ , 7 , J & Paid After End of Year 
after December 31, because there are many cases 

in which you find out after December 31 that you have more earnings 

than you thought you had. 

Mr. Piatt: One thing more on Mr. Silverson's statement. At the 

start he mentioned something about the reluctance of tax advisers to 

give an opinion which would minimize the risks under 102 or give 

the management assurance. I think that is quite 

^ 1 1 t_ j • it Tax Lawyers Should 

true. On the other hand, it seems to me that the 

job of tax lawyers, and I am sure Mr. Silverson ' ve p,nion ° S 

would agree, is first to sit down with manage- 
ment and help them come to an informed decision, work out all of 
the factors that are entering into the decision of how much dividends 
to pay and make a record which would adequately show the basis for 
the decision within the year; and then, finally — if he is asked — to give 
an opinion, which would appraise the risk. It is a very rare case where 
a tax lawyer would say there is no risk whatsoever, in the light of the 
uncertainties inherent in 102. 

Unidentified Speaker: On that point I might say that in our own 


practice it has never happened yet but if it ever does it will be over 
my dead body, that an opinion goes out, in writing, on 102. I should 
hate to have that letter get before the Tax Court or an agent. 

Unidentified Speaker: Well, off the record, I would say we are 
entirely different from you. We have many, many letters in the file 
where we go into a pretty complete discussion on the balance sheet 
and on the short-range and long-range requirements of the corpora- 
tion and come to a definite statement that in our opinion so much 
of the earnings should be distributed in this year. 

There is only one further thing there, and that is the comment that 
you cannot avoid a challenge under Section 102 unless you distribute 
100 per cent; the only possible way you can avoid a challenge. We've 
never had the slightest bit of difficulty. 

Mr. Ayers: That's not sure either. 

Unidentified Speaker: No, as a matter of fact, those letters, as a 
general rule, were on the basis of the general discussion at the last 
dividend meetings and sometimes are copied intact into the client's 
minutes. We don't mind; we are perfectly willing to stand by them. 

Unidentified Speaker: I'm not worried about the judgment but I 
don't want to put it in writing. (Laughter) 

Mr. George: Well, that is a difference of personal opinion. Mr. 
Miller, you are well up on this subject, what have you to tell us? 

Statement by Robert N. Miller 
Miller & Chevalier, Washington 
Mr. Miller: I suppose everybody's view as to the actual working 
of Section 102 depends upon the clients he has come in contact with. 
Like Mr. Mickey, I am a lawyer practicing in Washington; we Wash- 
ington lawyers do not have many Washington clients and our clients 
are in different parts of the country. From my contacts with clients I 
am led to think that the question of how far corporate taxpayers are 
now being influenced to declare dividends which they really ought 
not to declare is an important one. 

Approaching this question solely from the interest of the govern- 
ment, which stands to lose heavily in future income taxes if its corpo- 
rate taxpayers are hampered by limited capital, 
Present 102 Compulsion . _f J . . r ' . . . r 

my reeling: is that the present situation is tar 
Too Great for Future . ~ .: , . _ , ., - 

from satisfactory — considering, as I do, that the 
Welfare , . . , " . 

compulsion now exercised by Section 102 on 

certain classes of corporations whose welfare is important from a 
revenue standpoint is too great a compulsion. 


I am not now talking about that type of corporation the stock of 
which is owned by a group of people who do not need to get any 
income from it and who are, in fact, operating it with the purpose 
of plowing in earnings so as to bring about the maximum amount of 
unrealized appreciation in the stock of the corporation. I have in 
mind corporations of an entirely different type — mostly of a bona 
fide operating character and forming a group much more important 
to the government as regards aggregate tax revenues than the tax- 
conscious ones are. Section 102 is so broadly and drastically phrased 
that corporations of this latter type, as well as those of the consciously 
tax-avoiding type, must give attention to it if they are intelligently 

I disagree with those who feel that ignorance accounts for the fears 
entertained by some executives as to application of the section to 
corporations of a purely business type and that any excessive com- 
pulsive effect can be avoided by making them 

j , . , . . ' „ . , Do Not Agree That 

understand the real situation. The fact is that 

., , , , c 1 , . 1 Ignorance Accounts 

a considerable number of the taxpayers which 

are influenced by this fear are managed by in- 
telligent and well-informed executives. Their anxieties are not due to 
ignorance, but to knowledge as to how governments act when powers 
of penalizing taxpayers are phrased in such general language, and 
when political issues are involved. 

The question whether a possible effort on the part of the govern- 
ment can be defeated in court by the taxpayer corporation is not the 
question which most disturbs businessmen of the type I have men- 
tioned. They have to maintain for their corpora- 
tions favorable relations with the public and Lit, " 9<,Hon Bad for 
with their stockholders. However sound a pro- 
posed dividend policy is from the standpoint of the welfare of the 
company, and however certain the management is that it could be 
vindicated by litigation, it would be bad management to adopt it if 
there is any real chance it would have to be litigated. If it gets around 
that the government has claimed that the corporation has accumu- 
lated earnings beyond the need of the business, the resulting harm 
in public relations cannot be undone by court ajudication that the 
government was absolutely wrong. For this reason the point which 
has to be considered by the management is not what the courts would 
finally hold, but whether or not there is danger that, even mistakenly, 
the government would force an assessment under Section 102 to the 
point of litigation. 


Further, the mere assertion by a revenue agent of a Section 102 tax, 
though ill-advised and unfounded, may do such a corporation harm, 
even though there is no litigation about the tax. Unless the stock- 
holders are kept in ignorance of the fact that 
Mere Assertion by Agent . . , . 

the government has taken such a position, there 
May Be Harmful . _ & r . 

is danger 01 a strike suit by some minority 

stockholder, which would be given encouragement by the finding of 
the revenue agent, however erroneous. Litigation of this type is ex- 
pensive; it involves, as well, a public controversy as to affairs of the 

In the last analysis, an adjudication under Section 102 involves the 
exercise of judgment by government officials who cannot, in the 

nature of things, know as much about the corpo- 
Adjudication by , , . , , 

ration s problems as the corporation s own man- 
Officials Unfamiliar L . . . , , 

agement. Even in a situation where the manage- 
ment has excluded from consideration every 
circumstance except those bearing on the needs 
of the corporation and its future welfare, there is always a chance that 
the judgment of the revenue officials will lead them to a contrary 

I fully agree with Mr. Dixon that in general Section 102 is being 
administered gently and intelligently in the offices of most revenue 
agents in charge. Certainly a relatively small 
number of cases have come to the litigation 
minis ere sta ge, and I think it is also true that the num- 

ber of cases in which the applicability of the 
section has been raised is relatively very small, considering the number 
of corporate returns. 

Further, there is, as most of us know, a Mr. Bentson in the office 
of the Bureau in Washington who devotes his time to the administra- 
tion of Section 102. No one can talk to him without feeling great 
confidence in his judgment. If it were possible for Mr. Bentson to be 
the decider of each one of these cases, after the point has been raised 
in a local revenue agent's office, and if it were possible to insure that 
he would be left free to exercise that judgment, the management could 
sit back and feel pretty easy that its honest judgment would be con- 
firmed by authorities. Although it is not possible for one man to do 
all this, the influence of Mr. Bentson is a considerable force tending 
toward reasonable administration. But Section 102, over the years, has 
proved to be a section the administration of which is subject to 



political pressures. We who have been in Washington for years have 
observed that if a single Congressman makes a 
bitter speech attacking the Treasury for not en- 
forcing Section 102, almost invariably men like 

Mr. Bentson cease to be the deciders of policy. Higher-ups in the Treas- 
ury, having in mind the effect such criticism has on future votes, 
feel impelled to step in and tell such men as Mr. Bentson that different 
policies are to be put into effect. 

Thus, even if we assume that as at present administered the section 
does absolute justice to every taxpayer, it is a simple fact that man- 
agers of important industries are not justified in „ 

,1 ,. . . , Present Administrative 

assuming that present conditions as to the ad- 

• • „. r ^ • i< • 11 . • . Conditions May Not 

ministration of this politically sensitive section . 

will continue. It remains true that the section, 

as now drawn, gives very broad powers to the Commissioner and that 
the whole subject of corporate distributions is interesting to poli- 
ticians so that sudden changes of policy are always possible. 

The Commissioner cannot safely say he will enforce this provision 
less drastically than its written words require, and those words place 
on him the duty of examining all kinds of corporations with refer- 
ence to their dividend policy. All he can say, in effect, is "I will not 
apply the section unless in the judgment of my subordinates the sec- 
tion is applicable" — and this is poor reassurance. Furthermore, if the 
Commissioner sought to modify the rigors of Section 102 as drafted, 
such an assumption of power would be subject to almost certain 
reversal, when Congressional criticism points out that such limitation 
is beyond his power. 

As I have indicated, Section 102 is in my view properly favorable 
to our government's revenue interest in the case 
of corporations of certain types, and in fact is 102 Hecessar * in Case 
badly needed in its application to those types, ° f S ° me Cor t> orations 
but in the case of other types very important to But ,n ' ur,ous to 
the government the present Section 102 is in- * ers 

jurious to such interest. 

If this is true, ingenuity should be called into play to devise a new 
Section 102 which would in terms be so selective 
as between the different types that some of the NeW Se,ect,ve 

types would not have to consider Section 102 at Pr ° vis, '° n Shou,d 
all, but others would have to consider it. My e evl 

meaning can be best brought out by describing two of the many 


types which must be considered— one of these types requiring the 
compulsive effect of such a provision, the other not. 

At one end of the scale (extreme type No. 1), consider a corpora- 
tion the stock of which is owned by a group of persons who do not 
need to get any income from it and who are in fact operating it with 
the purpose of merely plowing in the earnings so as to bring about 
the maximum amount of unrealized appreciation in the stock of the 
corporation. Corporations of this type are oftenest engaged princi- 
pally in holding securities, but there are also some operating com- 
panies belonging in this category. So long as the government is com- 
mitted to the present policy of not only taxing corporate earnings 
at a relatively high rate to the corporation that earns them, but also 
relying for a considerable amount of revenue on taxing a stockholder 
who receives distributions, the government needs some kind of pro- 
vision of law tending to force this type of corporation to declare 
dividends. In a case of this type of corporation there appears to be 
no substantial consideration of revenue policy arguing against put- 
ting the operators of such corporation in sufficient fear so that they 
will be induced to declare dividends. 

At the other end of the scale (extreme type No. 2), consider a type 
much more commonly met with — a corporation which has stockhold- 
ers not averse to receiving substantial dividends, including some not 
in extremely high brackets, and in which the stockholders whose tax 
interest is strongly against substantial dividends have insufficient in- 
fluence to override the others. Most of the corporations of this type 
will be operating companies rather than investment companies. They 
are the corporations on which the government mainly relies for its 
heaviest revenues from income taxation, so that it is immensely to 
the government's interest that they shall prosper, and shall exercise 
the wisest possible business policy in deciding what, if any, part of 
the earnings ought to be distributed. 

It is thus my judgment, based on observation of clients, that Sec- 
tion 102, as it now is, operates against the government's interest in- 
stead of in favor of the government's interest, because a significant 
number of corporations of this type are caused to fear that their own 
entirely bona fide judgment may be misunderstood by government 
authorities unfamiliar with the company's peculiar problems. The 
government's interest suffers more by resulting overgenerous dividends 
than the government is benefited by the tax on such dividends. I feel 
sure that a very large number of corporations of this type do not 
happen to have difficult decisions under Section 102, and hence readily 


testify that they suffer no damage from such fear; but enough of them 
do suffer such impairment so that substantial harm is done. 

Between types as extreme as the two just mentioned, there are a 
large number of intermediate types. On this account it is certainly 
hard to decide just where to draw the line. The difficulty in drawing 
it is, in my judgment, no good reason for adhering to the present pro- 
vision which is definitely inapt as to a very large number of corpora- 
tions whose welfare is important from the government's standpoint 
as a collector of revenue. 

Considered with respect to the large class of corporations repre- 
sented by extreme type No. 2, 1 think the bad effects are not ascribable 
to methods of administration, but to the actual wording of the 
present Section 102. 

To illustrate what seems to me the unwisdom of trying to cover in 
one punitive provision the problems of all corporations, consider a 
zoo keeper who makes the same set of rules for dealing with his 
elephants and his small rodents. Obviously, they are all animals, but 
their natures are so different that it is foolish to try to deal with them 
under the same set of rules. A rule-drafter might say that it is easier 
to draft a single set of rules and that it is very hard to find proper 
lines of demarcation to be used in rules which discriminate between 
large and small animals and between gentle and fierce ones, but ease 
of drafting must yield to practical facts. 

This comparison seems to me applicable to the government's at- 
tempt to treat under the same rule various kinds of corporations whose 
purposes, activities, and distribution problems are so utterly different. 
We know that it is hard to draw a line, but that does not justify in- 
action. Nearly all tax problems are hard. If the government's interest 
requires us to draw a line, the line must be drawn, even though 
strong objections can be made, whatever place is chosen for drawing it. 

Another analogy will illustrate what is in my mind. Suppose the 
proprietor of a department store hates to have things stolen from his 
store by shoplifters. My, how he hates shoplifters! Well, if he is an 
experienced man who has been in business for a long time, what does 
he do about the situation? He knows that he can stop shoplifting 
absolutely; he could treat suspects and nonsuspects alike, having every 
customer specially scrutinized as he leaves the store. But as we all 
know, wise managers of retail stores, much as they hate shoplifting, 
are forced by circumstances to avoid any such stringent rule. As a 
matter of fact, considerations of policy make them refrain from prose- 
cuting known offenders except in extreme cases, such as those of 


repeaters. The proprietor knows that the honest people are more 
important to his business than the crooks are, and he would not 
think of enacting any general rule merely to gratify his hate of shop- 

The same kind of balance between conflicting considerations must 
be held in dealing with Section 102 as a government policy. Tax leaks 
due to corporations of certain types have to be curbed, but it does 
not seem sensible to do this curbing by a provision which threatens 
the welfare of other types of business which are more important to 
our revenues. 

If we determine that, however hard it may be to draw such a line, 

the interest of the government nevertheless requires that it be drawn, 

there are, obviously, two different approaches to a solution. We might 

draft the provision broadly as it is now, with a 
Exemption or Certain . x * 

proviso excepting certain classifications 01 corpo- 
Corporations by L . _ r . ° , _ r 

. , . , . rations from its general scope. Corporations so 

Arbitrary Lines _ _ _° _ L l 

carved out would not need to give any attention 

to Section 102 at all. For instance, one class of carved-out corporations 
might be those who have distributed as much as 70 per cent of their 
earnings. This would be coupled with a provision which would avoid 
any adverse effect in adjudicating the cases of those corporations which 
had not declared out so much. This could be attacked, of course, as 
an arbitrary drawing of the line, and this would be true whatever per- 
centage were adopted; but the fact is that it is better for the United 
States to have arbitrary lines drawn than to have legitimate corpora- 
tions put in fear to an extent which injures the government revenue. 
Another approach to the line-drawing problem, obviously, is to 
draft a narrower provision, which does not apply, even at the outset, 
to all corporations, but only to corporations of certain types which 
give real trouble in this connection. The stopping of loopholes is 
important, but it is a minor problem as compared with the problem 
of avoiding provisions of law which tend to impair the normal earn- 
ing power of corporations on which the taxing power depends largely 
for tax revenue. Thus, if Section 102 were made applicable only to 
relatively closely held corporations not mainly engaged in so-called 
operating businesses, and even if it were clear that this narrowing of 
the provision's scope allowed some leaks, though stopping the biggest 
ones, legislators would be sensible, as the department store managers 
are, in being guided by the broader considerations rather than the 
narrower ones. 


Discussion of Statement by Robert N. Miller 

Mr. George: That is very interesting. 

Mr. S. A. Smith: Mr. Chairman, I would question if it were de- 
sirable to draw a line like that. In the first place, it seems to me that 
there may be a very real question as to whether it is a good thing for 
the economy as a whole for the management of, . 

the big plants to be able to plow back all this k J e c «ons 

, . , A . Arbitrary Lines 

money that they can, as under your suggestion 

they could do. What you're really doing is substituting the decision 
of your board of directors for the decision of the market place; in 
other words if the money were paid out in dividends, then the stock- 
holders would have the choice of putting it back into stock with the 
same company or putting it somewhere else. As long as the directors 
make that decision, the stockholders are forced to contribute, to con- 
tinue to invest increasingly in the company, and they have no choice 
about it. 

Furthermore — going back to a question I was going to ask Mr. 
Dixon — you spoke about a table in Professor Williamson's mem- 
orandum, which showed that larger companies paid out more than 

small ones. One of the reasons why the small 

T . . t , .' Small Companies 

companies, I think, have not paid out more 

, . , . . , Need More Earnings 

is because they need it more, they have no 

other sources, and your big company can pay off more, and they can 
get it from other sources. They can either sell stock, if they can, or 
they can borrow it, and so on, and it seems to me that that makes 
a very great difference. Now, if you are going to exempt your big 
companies from 102, and I don't know how big a factor there is in 
making them pay out more — I haven't any idea — but in general theory 
it would mean that they would be able to attain more of their in- 
terest, which would mean that they would be borrowing less than 
these other sources, and so not taking advantage of their opportunities. 
The small companies would probably be enforced more drastically, 
and they are the ones who need their earnings much more for expan- 
sion, and after all, that's the way this country was built, through the 
plowing back of earnings. 

Mr. Dixon: Yes, if you had to draw such a line, to come back to 
his zoo example, your elephants could get some nice reserves together. 

Mr. Cann: Sure, and your poor mice would be just on a day- to- 
day ration. Supposing the rations are cut off for a period of three 
months, all your mice are gone, and nothing but the elephants are left. 


Mr. Miller: Well, those things have got to be taken into account. 
I see both sides of it, and I think size might have to be avoided in 
making any kind of comparison. 

Mr. Cann: You think that perhaps it should be redrafted with 
more exact standards. 

Mr. Miller: That's right. 

Mr. Cann: I think we all agree with that. 

Mr. Dixon: I'm not sure that I am in agreement with that. I've 

worked on many cases where definitions have been involved, and 

when you try to define and limit the thing, you 
Difficulties in . } } , , , & ; 

. , get into more trouble, and you open up more 

Drawing Arbitrary , . 1 ■, • • , 

loopholes. If the thing is properly administrated, 

with a proper leeway given by the courts, the 

proper leeway given to good faith, I would much prefer the law as 

it now stands, vague as it is, to anything which came down to very, 

very definite limitations. 

Mr. Cooper: The definition doesn't have to be limitation, that's 
the thing. You want a different kind of a definition, one that expands. 

Mr. Dixon: You can't define without limiting. You'll find that 
when you start in to draft anything. It is unfortunate, but you can't 
define without limiting. 

Mr. S. A. Smith: Well, as a small businessman, it sounds to me as 
though Mr. Dixon is the man I want to go to. 

Mr. Dixon: The finger is already pointing so directly at your 
closely held corporation, your small one — it is already in the grease, 
to the extent that there is grease here — that I would hesitate a long 
time before going along with drawing a line which would increase 
that pressure on the small corporation. And that's what it would do, 
if you, in effect, enlarged the classification of personal holding com- 
panies, or created a kind of middle ground between your personal 
holding company and your widely held corporation. It would in- 
crease the pressure on the little fellow and make things worse for him. 

Unidentified Speaker: In 1938, I think it was, the House passed a 
provision that would have imposed an undistributed profits tax on 
closely held companies, but the Senate kicked it out, and I think 
rightly so. 

Mr. George: But I am sympathetic toward Mr. Miller's suggestion 

that publicly owned companies be exempted 

Exemption of Publicly r , r„i • • t j »*. 

from 102, because as a tactual matter I don t 

ompames t h m k j-^gy ver y often take it into account. It is 
just a nuisance that bothers them, and if they are relieved of this 


nuisance they will feel better about it. I don't think it would seriously 
diminish the amount of dividends. 

Mr. Miller: I think they do take it into account, and they oughtn't 
to have to, because I think it is the wrong kind of compulsion on 

Mr. George: I think Mr. Smith has gone some distance toward 
answering the question, however — politically, it is quite impossible. 

Mr. Cann: I think it is too. I was just going to observe this, a 
little while ago, Mr. Dixon. One other factor — it isn't an economic 
factor, just one of the human factors — is that 
you happen to have, in Connecticut, one of the 
ablest agents, a man of extremely broad judg- 
ment. We have thirty-nine agents in charge, and they differ greatly in 
characteristics and in the way they run their offices. I don't know that 
when he said that he may have been thinking of the 102 situation, but 
I know that. 

Mr. Dixon: I know we have an extremely capable agent. We also 
have an extremely capable field force. It works both ways, however. 
While they are extremely capable and extremely fair, nevertheless, we 
get a going over on Section 102, depreciation, and all these other 
phases to an extent that is unheard of in the balance of the country. 

I have had many times reason to compare the administration, say, 
in the Detroit area, or the Chicago area, as against the administra- 
tion in Connecticut, and even compared with the New York area, the 
line as between capital expenditures and expense, for instance, is 
extremely rigid in Connecticut. Out in the midwest, why, they get 
away with murder, practically, so that we have a very tight adminis- 
tration in Connecticut. I prefer it because we have capable agents 
who will give a fair hearing, and an impartial hearing to all of the 

But if that same type of administration were applied to the other 
thirty-nine districts, I think we'd have a much better administration 
in this whole tax situation. 

Mr. Cann: Well, what I wanted to go on to observe, Mr. George, 

was this — the Bureau has administered this section very fairly, I think, 

on the whole. The instructions which have gone 

, r it _ ^ . . ^ -~ ~ Bureau Administration 

out trom the Commissioner or the Deputy Com- 

. . r - . . ./. ; . Generally Fair 

missioner 01 the income tax unit, either written 

or oral, have been towards a pretty liberal, fair administrative policy. 

I said in the beginning that I thought too much had been written, 

and I think there's even more fear than is justified. 


On the other hand, it seems to me to be unsound that the statute, 
as written, should remain as it is, in the light of the existing fear and 

the potential power that would rest in the hands 
But Statute as Written _ r . . . \ . 1 .• 1 j-rr 

of an administrator that took an entirely differ- 
ent view in the enforcement of 102. The poten- 
tialities of large deficiencies with three-year statute limitations are al- 
ways great. 

I would refer to a concern that since 1930 has made about six mil- 
lion dollars profits, owned by two stockholders, equally. Those earn- 
ings have been plowed back into the business. In addition to that, they 
at times, during seasonal operations, have had to borrow large sums 
of money. They have been consistently advised from year to year that 
they have nothing to concern themselves about 102. But, on the 
other hand, that particular company's returns happened to be open 
to 1942. 

Now, one day the president of that company said, "Assuming we 
haven't too much to concern ourselves about with 102, it is true that 
we have plowed back six million dollars worth of earnings in this 
business. Our distributions have been small." The two principal stock- 
holders and officers have substantial income from salaries and bonuses 
from this same company. Their wealth is substantially 100 per cent in 
this company. 

He said, "What might be our potential liability, if, for example, 
the Bureau should assert Section 102, even in a war year?" So we said, 
"Well, your potential liability is about three million dollars." Well, 
he said, "Isn't that something to think about, even though the risks 
are very, very small?" 

Now, I don't think the government has a chance, one in a thousand, 

of prevailing in any action, nor do I think they will propose it. But 

the actual asserting of any 102 liability in that case is going to rest 

in the hands of a revenue agent. It is conceiv- 
Assertion of 102 ^^ ^ ^^ ^ ^ ^ liability> whkh might 

ia 1 1 y y gen ^ e followed by successive examinations and suc- 
cessive assertions of liability. Now I simply sub- 
mit that a businessman, who is running his business right, ought not 
to have that kind of worry. Now, can he do anything about it? 

Mr. George: Isn't there some danger of running your point to an 
absurdity? There's a hazard in almost any act in life. 

Mr. Cann: Listen, we have hazards when we walk the street that 
an automobile may hit us, and we can't eliminate that. But can we 
eliminate some of these hazards in the tax laws? 


Mr. George: And still observe and still respect the intentions of 
the taxpayers? 

Mr. Cann: That's right. 

Mr. Rudick: How do we do it, Norman? 

Mr. Cann: Well, I think the section has got to be redrafted. I 
can't answer that, Harry, by laying out a draft here. 

Mr. Rudick: No, I don't mean by drafting 

, , . , Suggestions for 

the section, but in what ways do you think we „. 

,. . , ■ • , -n Change 

can eliminate the uncertainties, and still pro- 
tect the revenue? 

Mr. Cann: The revenue, for the purpose of the tax? 

Mr. Rudick: For the purpose of the tax, I mean. 

Mr. Cann: I think, I, of course, lean toward the shifting of the 
burden of proof. Secondly, I think it could be redrafted to provide for 
classification of certain types or classes of corporations along the line, 
maybe, that Mr. Miller has outlined, except I would have to differ 
with him on the subject of figures. 

Mr. Miller: You overemphasize that part of what I said, I think. 

Mr. Cann: I realize the political difficulty in securing such legis- 
lation. We've had statements from Treasury officials in this 102 field, 
covering certain aspects having a bearing on the application of Sec- 
tion 102; such statements have not yet been adequate. 

Possibly some further firm statement by the head of the Treasury 
Department, in the light of existing conditions today, and going into 
some detail as to when the Bureau will not assert Section 102, could 
be made and would help to clarify the air. 

Mr. Cooper: That can be done, because as a matter of fact, you 
can run into situations and take those very statements, as little as 
they go into detail, assert just one or two of the things they do men- 
tion, and you very often get to a revenue office and find out you can't 
use them. 

Mr. Cann: Yes, I agree with that to some extent, bu*. the policy 
from on high does permeate into the field offices of the Bureau. 

Mr. Miller: By the way, in answer to your question, you were 
speaking a moment ago as to the purpose of getting revenue. I'd 
like to know what is in your mind on that. 

Unidentified Speaker: I think it is nothing but a revenue act. 

Mr. George: Well, of course, I'm here primarily because I'm not 
an authority on such questions. But I do know my own impression 
on it, and that is that the primary purpose of it is to avoid improper 
accumulation and avoidance of surtaxes, rather than that of invest- 


ment. Actually, that is borne out by the facts, because the rev- 

. B iL enues from it have been insignificant, and 

Is Revenue the _ .. . .. , 

... . , as I recall, so insignificant that they have 
Objective of . ° _ . , ' 

. 7 never even been segregated in the Treasury 


Mr. Cooper: Except that you get the revenue on the dividends 
that are paid. 

Mr. George: You do get the revenue, and that is an important 
objective, but I would say the primary purpose of it is not revenue. 

Mr. Mickey: Well, Mr. George, it seems to me that perhaps some ef- 
fort should be made to find the facts on that question. Mr. Smith made 
the remark yesterday afternoon that he regarded the effect of 102 on 
revenue as insignificant. I think anyone who is going to take the facts 
that are found by this panel on the economic effect of 102 and use 
them for some purpose — the natural purpose would be for the in- 
fluencing of legislation — would necessarily have to have them but- 
tressed by some fact-finding on the other side of the case. 

There is nobody better equipped to do it than the people who 
deal with the taxpayers. The Treasury can do it, but they don't know 
what goes on in the directors' meetings, or in conferences with coun- 
sel, nearly so well as the counsel does himself. 

I personally think that if 102 were not there, there would be a 
shift, as Mr. Piatt suggested yesterday, to the corporate form of busi- 
ness by people who wanted to take advantage of the opportunity to 
distribute income in lean years or in loss years, and to use the corpo- 
rate form merely to build up reserve and then liquidate. 

Now, the extent to which that might be true is something on which 
it is just as essential to find facts as it is on the economic effect. 

Mr. George: Yes, I think that's true. Perhaps I should have amend- 
ed my statement in one respect. Of course revenue is a consideration, 
and one of the purposes of the act is to assess a penalty on improper 
accumulations, to catch the people who do not distribute the earnings 
of the corporation to the people who would have to pay the surtaxes. 
By that test, of course the actual amount of the penalty would not 
be a proper measure of the importance of the revenue that would 
result. The penalty merely accounts for those who do not observe the 
intention for which the act was passed. 

Mr. Dixon: Yes, but when you take Mr. Williamson's schedules 
that are attached to this statement 10 here and you see the small dis- 
tributions of all classes of corporations, I can't see that there can be 

See footnote one on page 31, 


anything significant of Section 102, even on personal surtaxes on that 
portion of the income, to the extent that it would amount to any- 
thing in the economy. 

If these figures show fairly heavy distributions, then you would say 
that there must have been an equivalent surtax paid by stockholders. 
But the answer is there's no such distribution shown in any of these 
tabulations. Therefore, the effect is bound to be minor. 

Mr. Rudick: Well, but if there were no 102, the distribution might 
even be smaller than they were. 

Mr. Dixon: No, I don't know. You take general business and 
these figures here, and I think that practically everything has been 
retained that is legitimately needed in the business. You look at this 
whole Section 102, and what have we got? We've got very, very few 
cases before the Tax Court. 

Mr. Rudick: Oh, I agree with you on that. 

Mr. Dixon: And most of them are flagrant cases. In other words, 

to put a broad view on the entire situation, the _ ,. „ . 

,. , . 1 r • 1 i Ordinary Businessman 

ordinary businessman, acting in good iaitn, has ,, ., ,..:,., . 

; . . . _ . & & „ Has No 102 Worries 

no worries on this Section 102 at all. 

Mr. Rudick: Granted, but if you didn't have Section 102, wouldn't 
a lot of people who are now doing business with partnerships or sole 
proprietors, incorporate, and accumulate in the corporation what they 
didn't need for their own living expenses, and avoid the surtax? 

Mr. Dixon: And that might not be a good effect. 

Mr. Rudick: No, I don't think it would. 

Mr. Dixon: That might not be a good effect, because it would 
affect the revenue from the individual taxes, so that we'd have a 
lessening of the government revenue, and you would have people 
piling it up, non-taxpaid, in their corporation, just to the limit they 
could get away with. In other words, I'm very much in favor of 
Section 102, because I don't feel that it hurts the average business- 
man and it does catch the chiselers. Now that's my honest feeling on it. 

Mr. Piatt: Well, in the final analysis, the purpose of 102, in broad 

terms, is to prevent abuse of the corporate method of doing business. 

It would be seen that the statute has been a ' , 

, , . n ... More Incorporations 

very real determining influence m having peo- 

, , , . r , . , , , , «* W 2 Were Removed 

pie make up their minds whether and how long 

they are going to operate in the corporate form. 

Mr. Moloney: Well, how can you evaluate that influence without 
having Mr. Dixon's statistical basis as to what the shift would be? 

Mr. Piatt: You've got to have it. 


Mr. Dixon: It is impossible. You are going, to some extent, back 
to the proposition as to whether you really need 102, even though you 
would permit, by absence of 102, some chiselers to get away with 
things. To go way back to the basic proposition, maybe we might be 
better off if there were more corporations and fewer individual busi- 
nesses, so that those corporations continued on, and we might be 
better off if our corporations were stronger, despite the fact that it 
will mean some loss of revenue, and despite the fact you will have 
claim cases, where it is a flagrant attempt to build up a value or a 
net worth in a corporation without paying individual taxes. Remem- 
ber you have a little different situation than you had when 102 first 
came in. You've got a 38 per cent corporate rate, and not a 12^ 
per cent rate. 

Likewise, you've got a different proposition on your state taxes on 
corporations. You've also got a much higher state tax, and when you 
get through figuring first the double tax on the income, it is a fact 
to be considered. Regarding your state tax, is the importance of it 
today as great as it was when it was first put in? 

Mr. Cann: Possibly, if we had a 5o per cent surtax ceiling a num- 
ber of these things we're talking about wouldn't mean so much either, 
but I don't advocate repeal of 102, Mr. George. I'm not convinced by 
my few years as an administrator that 102 has been effective, and 
neither do I think that we've done a great service for either the 
United States Treasury or our taxpayers by continuing to pile up, in 
a revenue statute, so many exempt provisions, many catchall provi- 
sions, to discipline these few chiselers we're talking about. 

Taxation has got to be viewed in the light of 150,000,000 people, 
and as we become a more and more disciplined community, I find 
myself sympathizing more and more with the American businessman. 

Mr. George: May I suggest a slight addition to the point I was 
making before about the reasons for the tax. I suppose that there are 
four motivations, at least, behind Congressional action in selecting any 
particular tax or in fashioning a tax structure, and those four are 
revenue, equity, economic effects, and politics, and it is with that 
diversity in mind that I made my original remark, which was per- 
haps not carefully enough considered, that I didn't regard revenue 
as by any means the sole, or perhaps the controlling, consideration. 
However, I shouldn't have made it so strongly. I didn't mean that it 
is not effective, because obviously it is. 

Mr. Cooper: I didn't want my remark to be taken to mean that I 
am in favor of repealing 102. I agree with Mr. Cann, I don't think 


we're ready to get rid of it, but I do think that factor is one that jus- 
tifies easing up on its restrictions, or easing up on 
its stiffness, either by statute regulations or other- 
wise, even if it does mean that there may be a few cases that might be 
taxed now that wouldn't be taxed under any change. 

You can still have, I think, something that will catch the chiseler 
that would not be of such wide import to business all over the coun- 
try, especially the smaller companies which gives them concern, and 
perhaps forces them to do things that they might not otherwise do. 

Unidentified Speaker: Do you think a measure of this type, a 
certain amendment, is sufficiently vital to the national welfare to 
require its continuance as opposed to the possible gains we would 
have by going back to individual management, instead of state super- 

Mr. Cooper: Well, go back to the basic proposition of first poli- 
tics, meaning that there is no sense in trying to get something you 
can't get, you might as well go for something that you might get, and 
improve the situation to that extent. I'm not satisfied that we have 
reached the point where it ought to be completely eliminated, although 
the complete elimination would not give rise to too much chiseling. 

Mr. Ayers: I'd like to make one suggestion here, and that is that 

there ought to be some exemption in that tax, as well as in the excess 

profits tax. In other words, to go back to Mr. «---« ^ 

£,.„ , , , ,. . & , , $25,000 Exemption 

Miller s zoo keeper s problem, it ought to be so 

we can forget about the mice in facts like this. If a corporation could 

accumulate, oh, say up to $25,000 a year, I don't think that they 

would ever get to be such a wicked octopus that we'd have to worry 

about them politically, and I don't think that the revenue would 

suffer appreciably. 

Mr. Cooper: Well, nobody bothers the corporation which accu- 
mulates $25,000 a year, now. 

Mr. Moloney: That's true, but since they don't apply it, why not 
put it in the law, so these people can — 

Mr. Rudick: Are you suggesting that there be an exemption for 
the first $25,000 of earnings? 

Mr. Cooper: That's what I had in mind. 

Mr. Moloney: Well, then you don't need 102. 

Mr. Rudick: Well, there might be another reaction on that, the 
agent might say, well anything over $25,000 — 

Mr. George: Of course, you've put up a question that we've tried 
to avoid throughout, and that to me is much more important, and 


that is the ungainliness of the tax structure, and one reason that we 

have to fuss about this thing so much is because it is merely a patch 

trying to hold some very incongruous parts of the tax law together. We 

try to talk of it logically, and the problem is not a logical problem. 

Professor Williamson, some time ago, gave me a question that we've 

woven in and out somewhat, and I would like to bring it up squarely 

here. Are the over-all data, as to percentage of 

earnings retained, which run higher than 30 
Over-all Data on 6 . . ' . , & . ,- 

per cent, significant, or nave they any lmplica- 
Retentions r . & _ . , ' /- J 

tion as to number 01 cases whose dividends are 

influenced? I refer to percentage by size groups of all corporations. 

In other words, what Professor Williamson is trying to understand 
is how much is concealed of these large aggregates, and what, in your 
opinion, is the actual range of cases. Is that right? 

Professor Williamson: You have been talking about the influence 
of the 70 per cent rule and referring to individual cases that you 
know about. My question relates to the problem of the aggregate 
effects of Section 102 upon dividend distributions. To what extent is 
the aggregate dividend effect of Section 102 reflected by the available 
statistics of corporate retentions? Can the proportionate influence of 
Section 102 upon dividend policy be judged from the over-all data? 

Mr. Dixon: I think, from the standpoint of Section 102 that these 

statistics are so obscured by other considerations that they don't afford 

a great deal of information, if any. I think that 
Statistics Obscured ,° . . . , t - 

these statistics, with respect to the earnings re- 

y # _ tained, are more a reflection of what the corpo- 

rations have had, as a matter of good business, 
to retain during this inflation spiral, in order to finance inventory, 
receivables, and plant expansion, all of which enter into the percentage 
of earnings retained. 

We have had a swerve to plant expansion during this period. We 
have had very heavy financing of inventories and of receivables. It is 
natural to suppose that '46, '47, and '48 should show very, very large 
retention of earnings. 

Now those factors are so predominant during those three years that 
any effect of Section 102 would be buried so far that you couldn't 
recognize it, in terms of percentage. That's merely my opinion. I don't 
know what the other gentlemen would say. We're speaking now 
purely of the statistics which are attached to this report. 11 

11 See footnote one on page 31. 


Mr. S. A. Smith: I'd like to raise one question in connection with 

retained earnings. In the small companies, isn't Reta|ned Earnings 

there a very marked situation where they take c , . 

J ' and salaries 

more out in the form of salaries, so that your 
retained earnings don't necessarily look as large? 

Mr. George: I have the same comment written on the margin of 
my table. 

Mr. Dixon: In other words, from a pure 102 standpoint, I don't 
think we can gain too much from these statistics. 

Mr. S. A. Smith: I don't think so either. I think there are other 

Mr. George: Anyone disagree? It reminds me of a label I put on 

the top of a table I compiled and viewed with „ t _ , .. . , 

r r . _ Cannot Gam Much from 

great disfavor after I had completed it. I put on 

the top, "Please be sure not to use these fig- 
ures." (Laughter) 

Professor Williamson: You will notice, Mr. Chairman, in my 
little memo I said, "Put here for judgment by the panel as to what 
the implications are." 

Mr. Ayers: Well, isn't the real answer to Professor Williamson's 
question the very thing again that Mr. Dixon raised? It is an almost 
impossible thing to ascertain. And then don't we get back — assuming 
we could get it — don't we then get down to the evaluation of a lot 
of psychological factors, which are the interplay of a number of minds 
working on the same problem, arriving at the same result? 

Mr. George: I suppose we could elaborate a little more — that cir- 
cumstances are equally diversified, and psychology plays hob with 
even those. 

Professor Williamson: Mr. George, may I put the question a little 
differently? Do the over-all figures as to percentages of profits retained 
in the aggregate by all corporations in each size class have any mean- 
ing as to the influence of Section 102? 

Mr. Dixon: No, I think that is just an average. I think that one 
thing that your table shows, probably as much as any one thing, is that 
your corporations of the $50,000 and $100,000 class are financing their 
operations and expenditures out of earnings, whereas corporations of 
$50,000,000 and over are doing their financing, not out of earnings, 
but by means of outside financing, or equity financing. 

Mr. Cooper: Apparently they don't need quite , 

as much, as they are not growing as much as ' c ■ „ . 
, ,, ' 00 an( j s ma || Companies 

the smaller companies are. 


Mr. Dixon: That's right, but they do, however, take advantage of 
the equity financing, rather than out of earnings, which is the more 
prevalent among the smaller companies. 

Mr. Cooper: Yes, well, as we've said, they've always done that. 

Mr. Silverson: I think the table also indicates that as the enforce- 
ment is increased companies have retained higher percentages of earn- 
ings than they had heretofore, right across the board, year by year. 

Mr. George: Well, you can dispense with '4i-'45 in any event, and 
that's why I'd rather look at the table with the '47-'48 estimate, which 
I think is more in line with the conditions that we faced in those 
years. Forty-nine is going to be entirely different, as fewer concerns 
will have a Section 102 problem in '49, except with respect to certain 
specific industries, perhaps textiles, about which we've heard a great 
deal around this table. I think that's an unusual situation that 
shouldn't be allowed to obscure the general corporate behavior of the 
country. Some of it is almost a local New York problem. 

Mr. Dixon: Well, I happened to examine the textile companies 
recently. In '49 they paid out a very much larger percentage of their 
earnings than they did in prior years. Their earnings have dropped. 

Mr. Rudick: Well, one doesn't need figures to tell him what was 
likely to have happened in the period such as that through which 
we've been passing. You had two things primarily — one was enormous 
expense, and the second is an effective loss of the depreciation reserves 
over the past ten or fifteen years, because of the depreciation of the 
dollar, and I think for those two reasons alone most people would be 
strongly influenced to accumulate an abnormal rate. 

The real question is, what is normal and what do we do then? 

Mr. George: There is another question from the management 
here: Can corporations acquire unlike subsidiaries with reinvested in- 
come? Can a soap company buy a cement com- 
pany without penalty under 102? That was 
Subsidiaries Without r . J r J , 

given me as a test question. It was suggested 

by a turn that the discussion took late last night. 
I don't know exactly what the circumstances were, but I'll give it to 
you in the abstract. 

Mr. Silverson: The regulations pretty nearly cover that — the un- 
related acquisition — and I would certainly be fearful of that. 

Mr. George: Well, let's get down to a concrete case. 

Unidentified Speaker: The du Pont Company. 

Mr. George: No, a smaller company — about a million and a half 
in assets. 


Unidentified Speaker: Its business has been the manufacture of 
trucks. That's a feast or famine business. You can take your cycles 
over the last fifty years, and you'll always have that feast or famine 
cycle. They managed to accumulate, out of war earnings, which were 
not subject to 102, thank goodness, some three or four hundred thou- 
sand dollars. They looked around and they bought into a valve busi- 
ness, running it as a separate division at the present time. Now there 
was an entirely unrelated type of business. Section 102, as I see it, 
won't particularly come into any consideration there. 

Now that was good business judgment, because they wanted a type 
of business that would offset the peaks and valleys of their main 
business. I think it was a good business deal, and I can't see Section 
102 disturbing anything like that. I put up an awful fight about it. 

Mr. Cooper: The business of a corporation is not merely that 
which it has previously carried on, but includes in general any line 
of business which it may undertake. A radical change of business, 
however, when a considerable surplus has been accumulated, may 
afford evidence of a purpose to avoid the surtax. 

Mr. George: Of course, we have yesterday's classic case, which 

bothered me at the time — maybe I attached too much importance to 

it — the case of the man who saw his market , . 

_ .. . Accumulation Because 

fading. He was energetic, enterprising, compe- r p j- ^ 

tent, restless, and he wasn't going to sit still and 

watch his business die. He was around looking for a new line. He 

accumulated. His motives are pure, as far as 102 is concerned. When 

he finds a new line it might be anywhere. 

Mr. Rudick: Well, if his motives are pure, he's supposed to win 
his case. 

Mr. George: Well, you're talking about morals, but I'm talking 
about the law. 

Mr. Rudick: I'm talking about the law. 

Mr. George: I'm just judging from the conversations around the 
table. If a man wanted to accumulate indefinitely without a goal that 
he could specify, that was clearly marked out, toward which he was 
aiming, would he be guilty? 

Mr. Cooper: Well, you just added two factors — that his present 
business was petering out and he knows it, and two, he was energetic 
and was looking around for something else. Now that's a little differ- 
ent from just accumulating because he might go into something else. 

Mr. Piatt: Can a real estate holding company, which does noth- 
ing but collect rents, acquire more real estate? 


Mr. Dixon: Well, that's a personal holding company. 

Mr. Cooper: Well, it has always seemed to me that there was a 
difference between buying a different business in a completely un- 
related line, and investment in controls of the stocks of another corpo- 
ration. There you are just buying investments. If the unrelated busi- 
ness was purchased completely, I've always considered that Section 102 
wouldn't apply. 

Mr. Moloney: Well, I would want to look at a few other factors, 
such as the dividend record of the acquiring company. If that acquir- 
ing company had not paid out dividends and made substantial ac- 
cumulations which it had not used or needed in its business, and 
then went out and acquired a business, I would be somewhat ashamed 
of it. 

Mr. Cann: I agree with Mr. Maloney. 

Mr. Miller: What significance is there in the fact that in the case 
of a big corporation the Section 102 question is seldom raised so sharp- 
ly? We have names that immediately come to mind, of course, like 
Kaiser and du Pont and lots of others, and they are spread all over the 
map in all sorts of diversified activities, wherever they see a chance in 
which they can put their money, take control, and make more money. 

Mr. Cooper: For one thing, some of them are separate corporations, 
such as the Kaiser-Fraser Automobile Company, and another thing, 
you'll find that some of those apparently unrelated industries are 

Mr. Miller: You mentioned, or started to mention du Pont. Are 
you coming back to the acquisition of General Motors stock? 

Mr. Cooper: General Motors, U. S. Rubber, etc. 

Mr. George: The argument is often advanced in that type of case 
that a tie-in stock purchase insures a market for your product. Of 
course, I think any time you do that you lay yourself open, and there 
would be a thunderbolt. But where you have the development of 
new products, for example, by du Pont, in its related fields, I don't 
think you have any question there about 102. 

I think you gentlemen are helping the Institute people make the 
distinction that they were looking for. All of you seem to agree that 
when they move so abruptly from soap to cement a question is raised. 

Mr. Cann: Let me add one more point to that, if you don't mind 
a slight interruption. Suppose that before they have accumulated any 
earnings they buy the cement plant, by issuing bonds and use the 
earnings to pay off the indebtedness — do you still think that they 
would be vulnerable? 


Mr. Moloney: It is a question as to whether or not you can use 
earnings to pay off debts. I've always assumed you could. 

Mr. George: I thought that was pretty well established. 

Mr. Ayers: Well, you incurred the debt for the very purpose of 
avoiding the imposition of the surtax. 

Mr. George: Professor Williamson would like to ask a question. 

Professor Williamson: About that debt problem— I gather from 
conversations that at times when businesses are being established, that 
is, corporations are being set up afresh, some- vulnerability of 
times they are set up with a substantial volume Corpor{|tions Using 
of debentures or other debt and a minimum Dgbt Financing 
amount of stock and available cash so that fu- AvoJd 1Q2 

ture realized profits can be utilized without vul- 
nerability to 102. The point that seems to be made with reference to 
this alleged practice is that 102 is, in that respect, a contributing factor 
toward utilization of debt financing rather than equity financing. I 
would like to ask if there is any more evidence about whether this 
practice is true. 

Mr. Miller: I feel certain that such decisions are influenced by 
Section 102. 

Professor Williamson: In other words, those cases are going to 
get caught? 

Mr. Silverson: There are quite a few. Another feature that may 
stop that sort of thing arises from the so-called "thin incorporation" 
doctrine under which debt may be considered stock, thereby exposing 
the creditor-stockholder to a possible dividend upon repayment of the 
alleged debt. 

I know, in my own case, that's been more of a deterrent than 
Section 102. 

Mr. Cooper: Well, I take it, the question arises where you have a 
form of debt that is questionable, whether the debt is or not. 

Mr. Moloney: That's what I wanted to know about. Is there really 
a difference? That is, between borrowings from stockholders and bor- 
rowing from banks? 

Mr. George: Oh yes, there is a vast difference. 

Mr. Moloney: Well, I was talking only to the point of quotations 
in the market, or from the bank or something like that, which I had 
thought to be legitimate, or rather assumed to be legitimate. 

Mr. Rudick: Was that what Professor Williamson was referring to? 

Professor Williamson: I mentioned debentures or bonds which 
might be issued by the corporation. 


Mr. Rudick: Then is it the question of 102? 

Mr. Dixon: Ordinarily, I'd say not. If the indebtedness is held by 
outsiders, then they are not vulnerable under 102. If it is held by the 
same group of stockholders, then they are vulnerable. 

Mr. Miller: Take this scheme which was actually put into effect 
prior to 1920. I recall that a Pittsburgh man, whose income was such 
as to put him in high brackets, created several corporations with the 
idea that each one would buy a large piece of real estate, paying very 
small down payments, and taking years to pay the balance. He thought 
that was a wonderful device to escape taxes on dividends, because he 
would have a good excuse for pouring the income of each corpora- 
tion back into the corporation — gradually paying off its debts. That 
furnishes a good example of a scheme to defeat the tax on dividends. 

Mr. Rudick: Yes, but maybe he could pay them in cash. But sup- 
pose he was an individual who couldn't buy, except on credit, and 
he didn't want to assume personal liability, so he organized a corpora- 
tion which would buy these properties on credit. Then, you couldn't 
say that 102 was good. 

Mr. Miller: No, you couldn't in that event. 

Mr. George: Dan, I've already introduced you. 

Statement by Dan Throop Smith 
Harvard University 

Professor D. T. Smith: I can make my remarks, I think, very 
briefly, Ed. I'm not quite sure why I am here for this particular panel, 
because my only basis for evidence is inquiries from gentlemen, such 
as the other members of the panel, which I make as I go around in 
my academic and research capacity, trying to find out the facts of life. 
Since here in this group the evidence has already come in from more 
diverse sources than I could possibly expect to pass on to you second- 
hand, I think I shall not attempt to add any additional points on the 
direct effects — 

Mr. George: You mean that you've learned by this time. 

Professor D. T. Smith: This has all been extremely useful from a 
selfish standpoint. As I wrote Miss Walker, I would be very glad to 
be here to pick up things, and I have. 

The evidence that we've had, from the standpoint of Treasury 
policy and Congressional policy, should be extremely useful in that it 
has pinpointed particular types of situations. In a sense it has served 
to debunk some of the very broad statements that have been made 
about what Section 102 has been doing, but at the same time, it has 


brought up a few perhaps more subtle things which of themselves 
may call for action. 

One thing, just for the sake of emphasis, I'd like to comment on 
and get in the record. Again and again remarks have been made as to 
what businessmen fear, even though they fear unreasonably and il- 
logically. Various of the periodical articles, indi- oik 

eating that the Tax Court is usually very rea- J^ J™^ 
sonable, seem to me frequently to miss the point, Unwillinqness 

because of the many people who aren't willing ^ 

to litigate or who aren't fully versed in what the 

Tax Court may hold. We've had a good deal of evidence here that 
business action is frequently taken ignorantly and unreasonably. This 
suggests that in a variety of ways, both through business associations 
and through governmental agencies, some of those fears might be 
alleviated, perhaps by restatements of Congressional and administra- 
tive intent. 

Now as to the significance of these results. The discussion has turned 
recurringly to the economic effects, which I take it you hoped only 
to bring up here and pass on to the subsequent panel. 

One thing that has struck me I had had in mind earlier. The evi- 
dence today seems to confirm it completely; I refer to the distinction 
between the cyclical and the longer-term effects of Section 102. From 
the cyclical standpoint, in terms of accentuating AccentUQtes Booms 
booms and busts in the economy, I suppose that 
virtually all effects of 102, both the logical and 

illogical ones, would be bad, and I see nothing in the evidence today 
that refutes that. Whether it is through the timing of dividend dis- 
tributions or the timing of capital expenditures, or even the timing 
of increases in inventory, the effects of 102 seem quite clearly to 
augment booms. Perhaps less positively, but as a derived result, they 
accentuate depressions. In the downswings, funds are not available to 
do the things which might otherwise be done, whether it is the main- 
tenance of dividends or capital expenditures. Section 102 thus dis- 
courages management action to mitigate cyclical fluctuations. 

The discussion today, with various participants indicating the im- 
portance of the immediacy doctrine which appears to be developing, 
has certainly added emphasis to the cyclical im- 
plications of .02. This is a subject which I iJJ^tl clZtei 
should think this panel would want to com- Pane| 

mend particularly to the subsequent panel. It is 
an area where a change of Treasury policy might well produce con- 


siderable alleviation, and it doesn't take an economist to indicate the 

desirability for such changes. 

With reference to the longer-term effects, my own conclusions have 

been that the evidence has been considerably less clear as regards the 

influence of 102 on aggregate capital investment. We have conflicting 

_ .j , _. evidence, or at least evidence both ways. Some 

Evidence Less Clear on . _ _. J 

, „ capital expenditures appear to be made sooner 

Influence on Aggregate , . A , . ,, , ,.,.„ 

^ . . , than they otherwise would be, and if they 

Capital Investment / ' 

weren t thus made earlier under the impetus of 

102, the situation might so change that they would not in the long 
run be made at all. On balance, my own observations and inquiries 
on this suggest that perhaps there has been somewhat more total capi- 
tal investment, even in the long run, as a result of Section 102. This 
is in spite of the fact that for a fair number of companies, because 
they choose not to do things presently and do make greater dividend 
distributions, they, in the long run, may not do quite so much as they 
otherwise would. 

But perhaps of equal importance is the matter of who is doing the 
expanding. Mr. Cann was the first one here to mention the importance 
of 102 in connection with mergers. My own thoughts and observations 

have been that estate tax considerations, either 
Importance as Element . . . . .,',-, 

. , , present or anticipated, were 01 considerably 

in Mergers x . A , „ .... 

more importance than Section 102 in bringing 

about the sale of the successful, closely held companies. The evidence 
today that has come in, I think, strongly indicates the need for more 
balance on the effects of taxation on mergers. From the standpoint of 
social policy, the maintenance of local control and individual or small 
group ownership is important. There is apparently more to be said 
than has been said heretofore in the literature on the importance of 
102 as a contributory element in mergers. The discussion today, it 
seems to me, has made a major contribution in that connection. 

As to some of the incidental results of 102, Mr. Smith has referred 
to the perquisites of ownership or management positions in small 

businesses. These are incidental, I would sup- 
Perquisites or . _ . ... 

■ . . pose, irom the general economic standpoint, 
Management Positions . , _ . t . _\ , 

. „ ., „ . though 01 great interest to those immediately 

in Small Business _ ° . _ _ ' 

concerned. They are, perhaps, one 01 those ad- 
ditional elements that make activity in closely controlled companies 
more attractive than a high-salaried position in a large company, 
where in some respects it is harder to get those perquisites because of 
public or stockholder reactions to them. 


I've thought a good deal as to the effects of a variety of taxes, in- 
cluding 102, on the corporate financial structures. There has been a 
fair amount of discussion on that today. It seems to apply particu- 
larly to the closely controlled companies, where, as Mr. Piatt sug- 
gested, you start as poor as possible — that is, 

poor from the balance sheet standpoint, if your 

r . . . . , * . Financial Structures 

trade position will permit it. I would point out, 

in connection with this, that though there is a great deal of general 
economic concern about the increasing corporate debt, it doesn't seem 
to have any very profound economic significance, in so far as closely 
controlled companies are concerned. If a small group puts up the 
funds, it is merely a question of whether they take common stock or 
debentures or perferred stock. Debt or preferred stock in such situa- 
tions doesn't produce the vulnerability to depression which you would 
have in a large, publicly held company where the debt is held by out- 
siders who might throw the company into bankruptcy, or the preferred 
stock is held by outsiders who will be yelling for dividends. This 
would not happen in closely controlled companies, where the same 
group holds all classes of securities. 

As regards publicly controlled companies, and the effects of 102 on 
their capital structure, expansion by debt financing, followed by a 
retirement of debt from retained earnings, seems to be a very com- 
mon procedure. Section 102 is an additional factor there, but by no 
means, I would guess, is it the predominant one or even a major factor. 

Those, I think, Mr. George, are the only things that I have to toss 
into the discussion. 

Discussion of Statement by Dan Throop Smith 
Mr. George: It was very interesting. Wouldn't some of you like 

to ask Professor Smith to elaborate on any of these points? Or to 

raise any others in which you are interested? 

Mr. Rudick: Have you any information on what the economic 

consequences would be on the repeal of 102, with no substitute? 

Professor D. T. Smith: It just seems to me so unreal to think of 

the repeal of 102 without a substitute that I 

, . . . . , . Tr Repeal Without 

haven t ffiven it any serious consideration. It we _ , . 

, , . ° ' . , . . Substitute Unreal 

don t have 102, we have to have something, just 

from the standpoint of sheer equity, to prevent these extreme situa- 

Perhaps this is beside the point, but in reading over some of the 
cases I must confess that I have been inclined, more or less, to hold 


my nose at the thought that such business practices could be under- 
taken with the expectation of even trying to get by. I don't think it 
is real to consider a complete repeal of some sort of Section 102 tax. 

Mr. Rudick: Some people seem to advocate that. 

Professor D. T. Smith: I don't see it. 

Mr. Turner: Well, don't they couple that repeal with the change 
in dividend situation? 

Mr. Rudick: Not all. They just ask for repeal, period. 

Mr. George: They couple it with general changes in the tax law, 
or tax structure. 

Mr. Ayers: Well, what would be the aggregate effect on revenue, 
supposing an absolute repeal were effected on 102? 

Mr. Austin: Now we can all speak freely, because none of us 
knows what we are talking about. 

Mr. Cann: Well, from the ordinary standpoint, I don't think it 
would mean very much. You would have some situations of accumu- 
lations for the specific purpose of avoiding surtaxes, that would be so 
extreme, and that eventually would come out in Congressional hear- 
ings, that they would bring about a Section 102 that really had teeth 
in it. 

Professor D. T. Smith: Now Mr. Rudick, by my statement here, 
I don't want to give the impression that I think everything is fine 
and rosy with 102, as it now stands. 

Mr. Rudick: Well, in those extreme cases wouldn't the govern- 
ment eventually get its share? 

Professor D. T. Smith: They may get their share eventually. 

Mr. Cooper: I suppose the immediate effect of the repeal of 102 

would be a great shift to the corporate manner 
Repeal Would Bring , , . _ ° __ u t 1 

of dome: business. You would have sole proprie- 
Shift to Corporate ° . . , ^_ 

tors moving into corporations, and the reverse 
Form 1 ■■• 

would stop. 

Unidentified Speaker: I can see the lawyers and accountants lobby- 
ing in Washington. 

Mr. Silverson: Well, one of the fears of a lot of people I have 

spoken to about 102 was that they make up their minds to pay, and 

they have to evaluate various factors, on whether 

<m x they think they are going to need this money or 

Disadvantage Because ' ,_. . ' " 1 . r^, ^ u • . 

not. Then they decide to keep it. Then their tax 

return is examined a couple of years later, and 
the things they feared didn't eventuate. There- 
fore, while your revenue agent is supposed to decide in the 


view of the situation two years ago, he can't but see how things came 
out, and the factors which showed things were going to come out 
right at that time appear much stronger than they did when the 
original decision was made. 

Mr. S. A. Smith: Would the collector permit a corporation to dis- 
burse at that time? 

Mr. George: There is no such provision in the law. 

Mr. S. A. Smith: No, I don't mean that. What I mean is that 
they feel that they don't get a square deal, in the sense that they 
don't know when the decision is reached what future conditions will 
be. In other words hindsight is much better than foresight, and they 
feel that they are liable to be penalized for keeping the fund, when 
they actually had a sound reason for keeping them, as they saw con- 
ditions at that time. 

Mr. George: Well, I was told once, in the Bureau of Internal 

Revenue, and of course, I'm not trying to attribute responsibility on 

a merely remembered statement, but I was told that the tax collector 

might permit them to disburse in a given year, the accumulations of 

the last two or three years, if they found that such a situation had 

eventuated as you describe. 

Mr. Cann: Well, cases have been settled by _ ..'•■» 

. _ _ . ., . Cases Have Been 

an agreement of the company to distribute in _. , . , _ 

, ;.".,-,,. Settled by Permitting 

the current year a large dividend, and in con- _, .. , , 

, , ;L , , , . r t • Company to Make Later 

sideration of that, the Bureau would modify his _. ., . 


Mr. George: Well, I'll wager that isn't a common practice. 

Mr. Cann: It is not a common practice. 

Mr. Rudick: Well, that is all I was asking about. After all you 
can't put everything in a statutory form for the administration of a 
provision like this. A great deal must rest upon discretion, no matter 
how much we try to stipulate, and I was just wondering if there was 
a fair degree of latitude in that respect, then part of the difficulty that 
has been cited here with respect to short term disappointments or 
changes in plans would be taken care of. Now that does not take 
care of the question of immediacy versus longer term plans for ex- 

Professor D. T. Smith: That is true, but I think if that were more 
widely known it would make a lot of people feel more comfortable. 

Mr. Austin: I don't think we could afford to let that go out as a 
correct statement of administrative policy, particularly under decen- 
tralization. You may have your case with the tax set-up in the agent's 


office, or in the technical staff, but certainly if it is in the docketed 

status, and you are out here in the field, in order 
Not Correct Statement , , , , , a 

to reach any such settlement as would attect a 
of Administrative , T 1 • 1 »j -^ 

subsequent year, I think you d agree with me, 

Harry, that you would have to go to the Commis- 
sioner's office in Washington to get that done. 

Mr. Ayers: It is not a general practice, by any means. 

Mr. Austin: It is a method of settlement, however, but I don't 
think it is one that you could tell the public you could rely upon. 

Mr. George: Doesn't that lie within the discretion of the revenue 
agent in the field? 

Mr. Austin: Well, at one time they used to make those in the 
field, quite a while ago. 

Unidentified Speaker: What they used to do in the field, many 
times where 102 tax was asserted, or 104, as the case may have been, 
was that they'd sit down and discuss a practical settlement with you, 
either along the lines of a suspension, or more particularly along the 
line of saying well, we'll settle with you on the basis of the surtax 
that would have been paid if you would have made the distribution 
in that year. That was frequently done, and it is still being done, I 
guess, as far as settlements are concerned. 

Mr. Austin: Does the corporation pay the surtax? 

Unidentified Speaker: No, sir. The corporation pays a tax in set- 
tlement, yes. 

Mr. Austin: In lieu of the surtax that would have been paid? 

Unidentified Speaker: That's correct. 

Mr. Ayers: Of course, under today's rates that is not a very prac- 
tical way. Years ago it was, in some cases. 

Mr. Austin: Well, there are a few cases, two or three, I think, 
in which the Tax Court has recognized a subsequent distribution as 
being balanced by the original retention. This is a preparatory meas- 
ure, that is, if you have a specific purpose for retention then you can 
distribute it and you can defend yourself against the tax by the gov- 

Concluding Discussion of Questions to be Referred to 

Policy Panel 

Mr. George: All that I have in mind in these closing minutes is to 

raise a few questions that have come to the surface in my own mind, 

as a result of the discussions. I'm not proposing the questions for 

debate here. They have already bounced over into the area of policy, 


which is beyond our charter, and are designed only for the considera- 
tion of the next panel if you think them suitable for that purpose. 

1. Is it possible for the Bureau of Internal Revenue to stipulate 
more exactly the conditions or purposes that will justify heavy reten- 
tions and those that will not, or are the particu- - . . . 

_ ' , P Stipulation of 

lars already as clear as they can be for a stop- - .. . 

J r . ' _, . x Conditions for 

gap type of tax, one that really has, as I con- 
ceive it, no independent existence in its own 

right at all, but merely as a corollary of the surtax public policy, and 
must the Bureau, of necessity, hold fairly closely to the principle that 
circumstances must control in each case? 

2. What can be done about the imminence, or the immediacy, issue? 
Should a business be allowed to accumulate against a period of de- 
pression, particularly if its records show substan- 

. , r ■ • • • 1 r Immediacy Issue 

tial use of its earnings over time, either tor 

maintenance of employment, or dividends, in the face of fluctuating 

sales, or for intermittent expansion, or intermittent development of 

new products? And over how much time? 

3. And speaking of time, does anyone have any opinion of the 

feasibility of averaffinsr accumulations over time, 

. . . , r , Averaging 

in determining proportions retained tor the pur- 
pose of this section, and again, over how much 
time, two years, four years, five years, or what? 

4. We've talked a lot about fear and ignorance. If fear and ig- 
norance, rather than actual vulnerability, are the major stimulants 

to either excessive disbursement or uneconomic • . ^„ 

. , . . „ . . Education to Offset 

investment, would it be safe for an organization _ . , 

. , ° , Fear and Ignorance 

or the government or somebody, to conduct an 

intensive campaign of education among corporations, setting forth 

in clear detail the circumstances believed to justify accumulations, and 

erring on the liberal side in doing so? And if this is not safe, is it right 

to say that the culprits are fear and ignorance? „ , r n rto 

aji! • x • j • i_i ■ i_ Burden of Proof 

5. And the last question: Is it desirable that 

the following panel take any position on the burden of proof? 

12 Editorial Note: The Small Business Advisory Committee of the Department 
of Commerce urged in a plan which it submitted to the Secretary of Commerce 
on April 19 that the Treasury Department be asked to define clearly what con- 
stitutes proper use of business income in order to bring to an end the confusion 
which now exists over the interpretation of Section 102 of the Internal Revenue 
Code. It was the position of the committee that the problems evolving out of 
Section 102 can be handled best through a revision of the Treasury's regulations 
which establish standards, such as the so-called 70 per cent rule. 


Now those are questions that entered my own mind as qualifying 
for consideration by a policy panel meeting specifically for that pur- 
pose. I know that there have been two days of discussion and 
I'm quite sure that my magnet has not picked up all of the scintil- 
lating things that have been said, or are entitled to further considera- 

I just wondered if you think that those would be proper questions 
to hand over, or if you wanted to add to them. 

There are two other sources of questions. Mr. Sibley has a little 
group of questions that he put together. Mr. Prerau has a question 
that he would like to add to the list. 

What is the best procedure? Would you like to comment on the 
ones I have suggested? 

Mr. Cooper: I think we might get the other questions all together, 
and get an idea of the whole, broad scope. 

Mr. George: Perhaps you are right. Mr. Sibley. 

Mr. Sibley: Mine aren't questions, exactly. They are rather state- 
ments for consideration. 

Distribution should not be limited to the year 
Distributions Should . , . , . , r , ,. 

of the earning, but a period of three succeeding 
Not Be Limited to 6' r o 

One Year yCarS ' 

Mr. George: We can convert that into a 

Mr. Cooper: We have brought up that item — over how long. 

Mr. Sibley: I say the right to reinvest should 
be inviolate if related to the business of the tax- 
payer. That can be converted into a question. 

A fair accumulation of 30 per cent in any 
one year should be unchallengeable. 

The decision of the board of directors should 
establish prima facie justification, only upset- 
table by preponderance of evidence to the con- 

30 Per Cent 

Decision of Board 

51 Per Cent 

Accumulation Within 

3 Years 

The use of 51 per cent of accumulation, with- 
in three years, should relieve taxpayer from 

This is a hot one — I don't think much of it 
myself. Approval of 75 per cent of the minority 
Approval of 75 Per Cent stockholders shall be conc i us i ve representing in 
of Stockholders oags of ^ Q per cent of the outstanding stock. 


The exemptions should apply to $100,000 of earnings per annum, 

that is, the exemption from the assessment. The „ . , „ 

. . . , . . . Exemptions and Penalty 

penalty should be 50 per cent or the present rate. 

Mr. Cooper: Fifty per cent of what was that? 

Mr. Sibley: Of the present rate. 

Mr. Cooper: Individual rates? 

Mr. Sibley: Penalty rate, in other words, half of 271/2 and half 
of 38. 

Mr. Mickey: Would the questions that they would consider in- 
clude the question that I'd like repeal? 

%jt s> r™ -ir i Tixr Consideration of Repeal 

Mr. George: That is before the table. You 

make your suggestions for the group to pass on them. 

Mr. Ayers: I think it has been pretty well answered by this group, 
but I just wondered whether or not they would want to say anything 
on it. 

Mr. George: Well, I will just say this much, we don't want to 
burden the other panel with merely academic questions upon which 
our own minds are already pretty clear. 

If it is the contention, or rather the consensus here that it would be 
either politically or practically impossible or undesirable to repeal 102, 
then I wouldn't see much sense in passing it on. 

Mr. Dixon: Well, why not relate that to a total revision of the 
tax structure? Dealing with Section 102, would they consider repeal, 
in light of the existing tax law? But if they are going beyond that 
then I think it should be considered. 

Mr. George: I think that is a very proper qualification. Personally 

I would enthuse over any responsible suggestion ^ , , _ . ■ 

r , . 1 t r 1 Overhauling Tax System 

tor the general overhauling of the tax system. 

We could pass that on mechanically. 

Mr. Piatt: I don't think we ought to pass too many questions on 
to this policy discussion panel. After all, they'll have a chance to read 
the record of our deliberations, and I think we should give them as 
free a hand as possible. 

Mr. George: Well, I think that is right. I would only say this 
much about it, that there is always a problem of crystallization and 
focusing after every general discussion, and the only purpose in fixing 
upon a few questions now is to test the extent of agreement among 
this group, who have talked for two days, as to what survive as 

Mr. Piatt: You don't mention the suggestion that is incorporated, 


I think, in one or two of the bills, that the 
ena ty n y pon p ena i t y tax b e applied only to the unreasonable 
part of the accumulation. I should think that 
the next panel ought to give some considera- 
tion to that. 

Mr. George: Let's consider that it is on the list for selection now. 

Mr. Prerau is representing J. K. Lasser, who is a member of the 
Panel Committee. He has a suggestion to offer. 

Mr. Prerau: This is not within the framework of a policy ques- 
tion, but it probably comes under fear and ignorance. That is the 
impact upon the directors. Mr. Cooper raised the question of passing 
a dividend, or having a dividend passed, be- 
i iry cause f f ear f personal liability as a result of 
the Trico settlement in New York. I wanted to know if there were 
any experiences along that line in that regard. Where the director 
probably puts himself in the position of — well, I might as well vote 
for dividends, because if I don't vote there is a possibility that I 
might be personally liable for failure to declare a dividend. 

Mr. Rudick: I think we did answer that one. 

Mr. Dixon: I think we answered that in the discussion, that we 
felt Trico had a very, very limited application, and that there have 
been no further cases since, along those lines. As long as the director 
acted in good faith, and along with good business policy for his corpo- 
ration, he has nothing to fear. I believe that was the sum and sub- 
stance of it. 

Mr. Rudick: Well, that was your experience, but I think some of 
us have felt that some directors of public corporations have been in- 
fluenced by the fact that — 

Mr. Dixon: Oh, they have been influenced by it, yes, but we think 
wrongly so, perhaps. 

Mr. George: Well, here at this moment, we reverse the previous 
rule, I assume. The previous rule was that we confine our attention to 
facts and not policy. Now we're trying to recapitulate and see what 
we think is important in policy. I would suspect we've done all we 
can in an effort to find agreement on facts. 

Mr. Dixon: I believe Mr. Prerau's question is more factual than 
the others we were discussing. 

Mr. George: It will appear in the record. 

Mr. Dixon: He probably wasn't here when it was discussed. 

Mr. George: Now are there any other questions? 

Mr. Miller: I have a question in the light of what I was saying 


before, and you might consider it. Would it be possible to redraft 

Section 102, so that first, if it were put in proper form, certain types 

of corporations which the government needs to 

,. , , ,. . , , ,. ., - t Exclusion of Certain 

police as regards dividend distribution would _. 
,.,,,, , . . Types or Corporations 

be included, and second, at the same time, it 

will not require consideration at all by certain other types of corpora- 
tions, which had best, in the government's interest, not be put under 
compulsion of this kind? That was just an attempt to put it in the 
form of a question, but I think it needs to be considered. 

The first step in that would be to say which type we are most 
interested in policing. The one we certainly are interested in policing 
would be one whose property was practically all in the type of assets 
that produce interest, dividends, royalties, and rents. That pure in- 
come items of that type, well we might say, all right, we can settle 
them immediately. And then try to move on, but not go the whole 
way. That was the thing that I thought might be considered by us. 

Mr. George: That seems reasonable. There are two kinds of dis- 
posals we can make. One is much easier than the other. We could con- 
sider all these questions on a vote basis and decide which ones we 
wish to recommend for consideration. Or we could approach them 
negatively and merely eliminate those of which we disapprove. 

In other words, if any question has been offered which, in the 
consensus is not particularly useful, then we eliminate it, but we 
wouldn't need to take a vote on every issue. 

Do you think that would be the simplest way? 

Mr. Ayers: Well, if it is a question of our collective opinion here, 
or our individual, why not have all of this deliberation as a basis for 
problems that are clear to us for consideration of the policy, from 
that point? 

Mr. George: You mean each suggest his own? 

Mr. Ayers: Just as they have gone in now, unless there are more 
additions. Obviously the policy panel is going to have to canvass the 
whole field, the same way that we have on our alleged factual pres- 

Mr. George: Well, there's not as great a difference in the two 
proposals as might appear, because the only purpose really in bring- 
ing questions to the general attention at all is the fact that when one 
man has an idea the others can, on the spot, point out to him some 
impracticalities about it, and it could be eliminated and lighten the 
load. It is only a matter of voting in that very primitive sense. 

Mr. Cooper: Well, I have no objection to any of those questions, 


or the basic questions of problems involved, going to the policy panel. 
I think possibly they might be reworded in some respect. A couple of 
them are mine and there are some duplications there, but as far as 
the basic idea is concerned, I think they are all fine. 

Mr. George: We don't have to refine them. This is just transmis- 
sion of ideas. 

Mr. Cann: I would favor those questions being submitted, in- 
cluding Mr. Miller's suggestion as to a study of the statute, with a 
view toward possible revision, without any final commitment by this 
group that it was in favor of any such revision, because after we 
looked at it we might be inclined to agree with Harry Rudick here 
that we had better keep what we've got and say nothing. 

Mr. George: That's true. Well, one of the conditions which I 
presented at the beginning was that we weren't going to become in- 
volved in any debate over them, simply whether we thought they were 
worth consideration by the panel whose business it is to consider 
such things. 

Mr. Dixon: Submit it on the basis that these are presented merely 
for consideration and are merely questions in our minds, and don't 
represent the thinking of the group at all, as a whole, but just merely 
questions we throw out for your consideration. Then I'd say, why 
don't you constitute a committee of one to combine these particular 
questions and get them into form for presentation to the policy- 
making committee. 

Mr. George: Then, is that generally agreed? 

Are there any others anybody would like to add? If so, they can 
do that privately, I suppose. 

Mr. S. A. Smith: I think you might include the question of divi- 
dends immediately following the end of the 

Dividends Pa^After ^^ ^ ^ diyidends paid within the first 

two and a half months of the succeeding year. 

Mr. Dixon: Isn't that actually taken into consideration now? 

Mr. S. A. Smith: No sir. 

A field man told me — we have a fiscal year ending June 30, and 
we never know how we stand until after the first of the year. For years 
the dividend has always been paid within sixty days or so — 

Mr. Dixon: As far as regulations are concerned, no. So far as an 
agent's own feeling on the matter perhaps he might take it into 

Mr. Rudick: When it is a question of whether you are liable or 
not, they do take into account dividends before or after the end of 


the year, but if they had determined that you were liable, then that 
is different. 

Mr. Cooper: Then suppose you do go and pay a dividend, a sub- 
stantial one, after the end of the year, and they say you're still liable, 
then you lose the benefits. 

Mr. Cann: That's right. Yes, I agree with you on that. 

Mr. George, Mr. Silverson suggested some possible changes in ad- 
ministrative consideration of these matters. I don't know that I am 
in agreement with him on them, but there are 

lots of people who are, and possibly he might 

r . . ,, . , . . , Administrative 

want to refer that to them. Mainly, his remarks, 

, . t _ _ Considerations 

as I understood them, contemplated some cen- 
tralization of this problem in Washington, as distinguished from 
finality in the field. 

Mr. Silverson: I've worded a question. Should a proposed 102 de- 
ficiency be approved by a special section of the Bureau in Washing- 
ton before the taxpayer is called upon to defend his position? 

Mr. George: No objection is there? 

I'd like to say for my own part that I've derived some very special 
values from this panel. I don't think I've ever known a group that 
settled so quickly into a friendly and useful working relationship. 
Also, I'm quite sure that the record will show a high level of integrity 
and detachment, and of ability to think of these problems in terms 
of the public interest, that is quite above the ordinary. 


Summary Comment on Fact-Finding Panel 

K. M. Williamson 

Wesley an University 

The accompanying transcript of the deliberations of the fact-finding 
panel speaks for itself. This summary comment is not intended to 
serve as a substitute for the study of the document itself. Such a sum- 
mary must condense and select, and present the highlights of the 
apparent trends of emphasis and consensus. The function of the sum- 
mary, together with the topical index and the synopsis, is to assist the 
reader in making his own appraisal of the significance of the findings 
by the fact-finding panel. 

As the agenda of the panel were formulated by its chairman, Mr. 
George, the members of the group were directed to concern them- 
selves chiefly with "the direct influence [of Section 102] on the actions 
and policies of corporations," but participants were permitted to 
offer views also as to the aggregate effect of the law upon all corpora- 
tions and the economy as a whole. 

Main Problems Considered 
The results of the panel may be conveniently summarized under 
the following heads: (1) types of effects discussed, (2) contrary ten- 
dencies, (3) other aspects of the consequences of the law, and (4) the 
probable dimensions of the over-all influence of the section as to the 
area of vulnerability and proportionate impact upon the corporate 
units of the country. 

Types of Effects 
As to types of effects, one question which received much attention 
was the influence of Section 102 upon dividend policy. It seems to 
have been fairly generally admitted that, in a limited but undeter- 
mined number of cases, consideration of 102 has caused some dis- 



tribution of dividends that, in the absence of the section, would not 
have been made. Though there was perhaps some difference of opin- 
ion as to the extent of this influence, there appears to have been 
fairly general agreement that the actual effect on dividends is very 
much less than some of the literature would indicate and that, so 
far as the effect exists, it is chiefly limited to certain types of corpora- 
tions. For the various positions and differences in emphasis of partici- 
pants as to the dividend distribution effect, the reader is referred to 
the page references in the topical index and synopsis. 

Many other effects besides dividend distribution were brought be- 
fore the panel. Because of limitations of space these various actions 
cannot be detailed here but the reader is referred to the topical index 
and synopsis and to the various pages indicated, for the several effects 
mentioned. In summary, suffice it to say that some of these decisions 
were in the direction of increasing accumulation, and others were not. 
There was some apparent difference of view as to the economic effects 
of such nondistribution practices, but several participants appeared to 
discount both their frequency and their economic significance for the 
economy as a whole. Others, admitting the small aggregate effect of 
such actions in individual cases, were nevertheless disposed to regard 
them as undesirable. 

Contrary Tendencies 
One of the most striking observations is that the evidence brought 
out by the panel seems to show contrary tendencies as to the influ- 
ence of Section 102 on corporate investment and plant and equip- 
ment expansion. Statements show that considerations of 102 operate 
both ways — both to stimulate and to retard such investment and ex- 
pansion. Some participants stressed the stimulation, the hastening or 
overdoing of investment, while others pointed to prevention of invest- 
ment and growth. It is difficult to estimate the net over-all effects upon 
such investment. It is significant, however, that one participant after 
listening to the discussion, said: 

On balance, my own observations and inquiries on this suggest that perhaps there 
has been somewhat more total capital investment, even in the long run, as a result 
of Section 102. This is in spite of the fact that for a fair number of companies, 
because they choose not to do things presently and do make greater dividend dis- 
tributions, they, in the long run, may not do quite so much as they otherwise 

iDan Throop Smith, p. 166. 


If this is a fair characterization of the balance of the evidence, the 
conclusion is a significant finding and controverts the apparent impli- 
cations of much of the literature on Section 102. 

Other Aspects of the Consequences of the Law 
In addition to these effects, the discussion by the panel brought out 
other aspects of the influence of Section 102, characterized by one par- 
ticipant as "perhaps more subtle things." 2 One matter on which con- 
siderable stress was placed was that there seemed to be widespread 
unreasonable fear and ignorance as to the intent and application of 
102. There was evidence that, in many cases, actions taken by man- 
agement are due to unjustifiable fear, misunderstanding, or overcon- 
servative advice from tax practitioners. On the other hand, it was 
stated also that, in many cases, concern for 102 gives rise to worry 
and uncertainty but does not lead to actual business actions which 
would not be taken in the absence of the law. 

Another factor which received recurrent mention throughout the 
discussion was the influence of the so-called "immediacy doctrine," 
which has governed decisions in some of the 102 cases. This doctrine 
is apparently widely thought to mean that a corporation may not, 
without penalty, retain profits for a business purpose unless the money 
is immediately used or plans and commitments are made to evidence 
actual intent to utilize the funds for the purpose claimed. Many par- 
ticipants seemed to think that the "immediacy" principle caused man- 
agements either not to retain and, thus, slow down eventual growth 
or to hasten their investment expenditures and execute their expan- 
sion plans prematurely. The influence of this "immediacy doctrine" 
was stressed fairly generally by the participants, though no quantita- 
tive measure of its aggregate effect in individual cases was given. 

The effect of Section 102 on mergers and sales of businesses was 
also given considerable attention. Some participants expressed the 
view that Section 102, coupled with the estate tax, and presumably 
the capital gains tax, operated as a "contributory factor" in stimula- 
tion of the sale and purchase of businesses. No judgment was given 
as to the frequency of this effect of 102, but it was emphasized that 
any such consequence tends to promote concentration or to reduce 
the number of smaller and locally managed enterprises. One partici- 
pant who, before, had been disposed to regard the estate tax as a 
more important factor than 102 in influencing mergers stated: 

Dan Throop Smith, p. 165. 


The evidence today that has come in, I think strongly indicates the need for more 
balance on the effects of taxation on mergers. From the standpoint of social policy, 
the maintenance of local control and individual or small group ownership is im- 
portant. There is apparently more to be said than has been said heretofore in the 
literature on the importance of 102, as a contributory element in mergers. The dis- 
cussion today, it seems to me, has made a major contribution in that connection.3 

Evidence was also given that Section 102 has been responsible for 
some debt-financing. It was stated that when new corporations are 
set up, they are, in some cases, "started off poor," with considerable 
borrowing so that subsequent earnings may be used, under 102, to 
retire the debt. One participant stated that in the case of debt financ- 
ing by publicly controlled companies, "Section 102 is an additional 
factor . . . but by no means ... is it the predominant one or even a 
major factor." 4 Another participant was disposed to attribute debt- 
financing chiefly to the state of the equity market rather than to con- 
siderations of Section 102. Some participants tended to doubt whether 
utilization of earnings for debt-financing is clearly invulnerable 
under Section 102. 5 The view was also expressed that encouragement 
to debt-financing in the case of closely held corporations, where the 
same group is putting up the money, is not economically significant. 
This conclusion is based upon the consideration that the group would 
not be vulnerable, in time of depression, as is possible in publicly 
held concerns, because of the claims of outside holders of senior 

Another effect, less frequently mentioned in the literature, brought 
before the panel is that Section 102 is a deterrent to funding of de- 
preciation reserves or, as one participant put it, that the provision 
causes corporations to keep funds in cash or government bonds rather 
than in securities of other businesses, lest, because of such holdings in 
unrelated businesses, they imperil their position under Section 102. 6 

Probable Dimensions of the Over-all Influence 
of Section 102 
The difficulty of isolating the influence of Section 102 from that of 
many other factors which motivate management decisions was rec- 
ognized by the panel. The discussions accordingly reveal some differ- 
ences in emphasis as to the responsibility of Section 102 in individual 
cases. On the other hand, some participants did tend to indicate their 

3 Dan Throop Smith, p. 166. 

4 Dan Throop Smith, p. 167. 

5 Discussion, pp. 162-64. 

6 Harry J. Rudick, pp. 59-60. 


conceptions of the over-all significance of the 102 influence. They did 
not arrive at any precise statistical or quantitative estimate of the 
effects of the provision, but several did express their views as to the 
industrial classifications, types, and proportion of corporations which 
were vulnerable to Section 102. The trend of opinion seemed to sup- 
port the view that the impact of the section was limited chiefly to 
closely held corporations and to those large or publicly held corpora- 
tions in which dominant control resides in a single individual or a 
small group. Some evidence indicated that corporations in certain 
industries such as textiles were more subject than others to 102 prob- 
lems. The areas of least and greatest effect of Section 102, such as it 
is, was stated by one participant as follows: 

. . . The effect of Section 102 such as it is, is the least on industries which have 
heavy capital investments . . . are heavily debt-financed . . . have low turn- 
overs of inventories or of receivables . . . are engaged in manufacturing . . . and, 
of course, publicly-held industries. On the contrary . . . the effect will be greatest 
on light industries, on debt-free industries ... on those which are engaged in 
jobbing and distribution and service activities, those which have high turnover of 
inventories and receivables and those which are closely held. By closely held I mean 
. . . that dominance of control is closely held by a groupJ 

Though there were variations, the view of several seemed to be 
that the proportion of the corporations affected by 102 is small, and 
that the effect of the section has been very much less than many 
have apparently supposed. Some participants gave the impression that 
the over-all influence of the section is, in the aggregate, quantita- 
tively not significant. Such expressions as these appear in the tran- 
script: "As to its general effect, I am a little dubious about its over-all 
impressiveness;" 8 "no conclusive proof that it has had a significant 
influence in that direction [forcing dividends];" 9 "too much has been 
written on this subject;" 10 "so far as dividends are concerned . . . and 
. . . spending and corporate rearrangements . . . the statute doesn't 
have a very significant effect on the actions of businessmen;" 11 "the 
gist of it is that they [businessmen] worry, and, when they get through 
worrying they go ahead and take their business actions . . . and go 
ahead on that basis, hoping to God nothing happens;" 12 "there has 
been a great deal of testimony that there is not an appreciable number 

7 Maurice Austin, pp. 39-40. 

8 Maurice Austin, p. 41. 

9 Harry J. Rudick, p. 58. 
!0 Norman D. Cann, p. 44. 

11 Joseph S. Piatt, p. 87. 

12 S. Abbot Smith, p. 96. 


of taxpayers who even have the 102 problem;" 13 "I think there is 
nothing to fear from Section 102, by any management or board who 
act in good faith giving first consideration to the corporation's own 
problems ... [the exceptions] are too small in percentage, too small 
in number and the dollars involved do not amount to peanuts along- 
side of the general economy." 14 

The over-all significance of the panel's findings as to the effect of 
Section 102 was stated by one of the participants as follows: 

The evidence that we've had from the standpoint of Treasury policy and Con- 
gressional policy should be extremely useful in that it has pinpointed particular 
types of situations. In a sense it has served to debunk some of the very broad 
statements that have been made about what Section 102 has been doing, but, at 
the same time it has brought up a few perhaps more subtle things which of them- 
selves may call for action. 1 ^ 

In summary, as to the over-all effects, it seems fair to say that some 
of the evidence of the fact-finding panel reduces the conception of the 
dimensions of the problem of Section 102 as compared with the im- 
plications of much of the literature on the subject. 16 

Questions of Policy Recommended for Study by the 
Panel Committee 
On the basis of the transcript it appears that many of the partici- 
pants felt that Section 102 in some form, under present conditions, 
is necessary and should not be repealed. Many suggested, however, 
the need of amelioration and modification of the law. Before adjourn- 
ment, therefore, the chairman and other members of the panel sug- 
gested certain questions of policy as to Section 102 to be passed on to 
the forthcoming policy panel for their consideration. These questions 
were to be transmitted to the policy panel without any implications 
as to the attitude of the individual participants with respect to the 
policies involved. The questions are the following: 

is Paul Mickey, p. 98. 

"Albert Dixon, Jr., p. 125. 

is Dan Throop Smith, pp. 164-65. 

16 It should be explained, for the record, that the above statement does not at- 
tempt to set forth the balance of the weight of opinion of the participants as a 
whole as to the over-all quantitative impact of Section 102. Some participants did 
not give estimates of the aggregate proportionate effect of the Section. Others, while 
conceding that, in percentage, the number of corporations affected was small, or 
limited to certain categories, nevertheless held that the effect was bad. Others 
stressed the potential effect of the Section. For the various opinions the reader 
should consult the page references shown in the Topical Index following this sum- 
mary, and the Synopsis preceding Part 1. 


1. Is it possible and desirable for the Bureau of Internal Revenue to stipulate 
more exactly the conditions or purposes that will justify heavy retentions under 
Section 102, and those that will not? 

2. What about the "immediacy" issue under Section 102? Should business be 
allowed to accumulate against a period of depression, particularly if its records 
show substantial use of its earnings over time for maintenance of employment, 
stabilization of dividends to offset fluctuating sales, for intermittent expansion 
or intermittent development of new products? And over how much time? 

3. Would it be feasible to average accumulations over time in determining 
the allowable proportions of earnings retained under Section 102, and over how 
long? Two, four, five years, or over what period? 

4. Would it be safe for government or some other agency to conduct a cam- 
paign of education of corporate managements as to the justifiable bases of ac- 
cumulation under 102? 

5. Is it desirable that the policy panel should take any position on changing 
the burden of proof under Section 102? 

6. Should the penalty under Section 102 be applied only to the unreasonable 
part of the accumulation? 

7. Would it be feasible and desirable to redraft Section 102 so that it would 
require consideration and policing of only those corporations whose dividend 
distributions need to receive the attention of the government? 

8. Would it be feasible and desirable to allow corporations to satisfy the re- 
quirements of Section 102 by additional dividends paid within two and a half 
months after the close of the fiscal year? 

9. Should a proposed 102 deficiency be approved by a special section of the 
Bureau at Washington before the taxpayer is called upon to defend his position? 

10. Should the right to invest be inviolable if the investment is related to the 
business of the taxpayer? 

11. Should an accumulation of 30 per cent in any one year be unchallengeable? 

12. Should use of 51 per cent of the accumulation within 3 years relieve the 
taxpayer from challenge? 

13. Should an exemption of $100,000 of earnings be allowed in assessing 102 

14. Should the penalty tax rate be reduced by half? 

Topical Index to Fact-Finding Panel Discussion 


1. Fact-finding as the task, 28-29 

2. Screening and evaluation of evidence as to economic effects of Section 102 
as an aim of the panel, 31-32 

3. Three possible levels of analysis of section, 29-30 

4. Emphasis of panel centered on direct effects of Section 102 upon business 
action of taxpayer as job of panel, 32 

5. Warning as to difficulty of judging causation of effects, 28-32 


1. Difficulty of quantitative measure of effects, 38 

2. Comments on significance of Bureau data of 102 enforcement activity, 

3. Comments on over-all statistics of proportionate retention of corporate 
earnings, 159-60 

4. Opinion as to frequency and aggregate of economic effects by individual 
participants, 39-50, 58-60, 67, 74-75, 86-90, 94-98, 100, 116, 123-24, 146, 
150-55, 165-66 

5. Taking chances under 102, 42, 60, 96, 115 


6. Variability of impact of 102 with certain factors 

a. Profits and business conditions, 39-40 

b. Shift of Treasury attitude, 39, 95, 145 

c. Geographical variation in severity and attitude of revenue agents, 108, 
128, 135, 144-45. *5* 

d. Variations with years, 39, 44, 93, 123 

e. Variation with attitude of counsel, 126, 129, i34"35 


1. General statement of characteristics of business of greatest and least 
exposure, 39-40, 84-85 

2. Distribution of stock holdings, 39-40, 44, 85 

3. Size, 36 

4. Recurrent references to textiles, 42, 45, 64-65, 139-40 

5. Nonmanufacturing, 39-40 

6. Fortuitous impact, 40 

7. Special circumstances of certain industries, 83 

8. Special financial conditions of certain corporations, 103-4 


1. Forcing dividends, 38, 44, 48, 49, 58, 64-65, 82, 97, 102-3, "O-is 

2. Stimulation of business expenditures 

a. Plant and equipment expenditures, 38, 59, 73, 86-87, 89-91, 97, 166 

b. "Immediacy doctrine" and investment, 40, 51, 60, 68, 123, 126, 128, 

c. Year-end actions (orders, inventories, receivables, etc.), 38, 59, 81-83, 86 

d. Salaries, 85, 159 

e. Bonuses, 86-87 

f. Special benefits to executives, 95, 166 

3. Restrictive effects on certain business actions 

a. Retardation of growth of small business, 41, 68, 74-76, 123-24, 126 

b. Limitation of working capital, 58, 123-24, 126 

c. Prevention of contingency reserves, 40, 59, 80-81, 99-101 

d. Prevention of depression reserves, 99-101 

e. Delay of commitments while waiting for audits on 102, 41 

f. Reduction of investment in equity securities, 47, 59-60, 130, 136 

g. Indefinite status of corporate purchase of plant engaged in non-allied 
lines, 160 

h. Retardation of new ventures and new products, 59, 74*75' 10 5- 6 

4. Sales of businesses, 46-47, 50-51, 55-57, 87, 97, 112 

5. Stimulation of debt-financing, 38-39, 58, 76, 87, 162-64, 167 

6. Conversion of corporations into partnerships, 38 

7. Accentuation of booms and busts, 165 


1. Unreasonable fear and ignorance as to 102 as factor in business decisions, 
39, 43, 44, 60-61, 69, 80, 91-92, 96, 108-11, 125, 143. l6 5 

2. Uncertainty as to directors' liability as a factor in decisions, 50, 115-20, 

3. Reluctance to litigate as factor in vulnerability, 135-36, 143 

4. Uncertainty and worry but no action, 42, 60, 78, 96, 115 

5. Advantages of documentation and careful appraisal of financial planning, 
86, 96, 115 


6. Use of 102 as bargaining factor in adjustment of other liabilities, 88 

7. Revenue effects, 153-57 

8. Good effects versus bad effects of Section 102, 60, 97-98, 167-68 


1. Complexity of factors in dividend decisions, 31-32, 109-12 

2. Differences in participants' appraisal of motivational significance of 102 
in various decisions, 76-77, 87, 89-91, 113-16 


VIII. SPECIFIC CASES DESCRIBED, 45-47, 49, 52-56, 64-66, 74-76, 83, 88-90, 99, 
104, 109-13, 123-24 

PANEL, 171-77 

Policy Discussion Panel on Section 102 

Introductory Statement by Edwin B. George 

Director, Department of Economics, Dun & Bradstreet, Inc. 

Mr. George: For the record, I'd like to say briefly what the purpose 
of this meeting is, and something about its background. The meeting 
itself I regard as the climax to a carefully organized inquiry into the 
practical and economic effects of Section 102. Its purpose is to decide 
what, if anything, should be done about it. 

I believe that you are generally familiar with the sequence of events 
that has led up to this finale. Professor K. M. Williamson of Wesleyan 

University initiated the project with an intro- „ ,. . 

j i-i 111 -ii Preliminary 

auctory analysis that was based substantially , . . 

•,.._,, , Investigations 

on personal interviews. Then came the ques- 
tionnaire survey under the auspices of the Tax Institute. The question- 
naires were sent out to several hundred tax practitioners, and there 
were about one hundred and fifty fully filled-in returns, supplemented 
by about thirty-six letters of comment. Then followed the fact-finding 
panel, Panel Number One, and Professor Williamson's summary com- 
ments on its deliberations. 

Panel Number One — to stress the distinction at the outset — was in- 
structed to assess the quality of the evidence that was originating, 
both in the survey and in the professional experience of those par- 
ticipating. You have the results in galley proof form, and I trust that 
you have had an opportunity to examine them. 

My own impression was that the discussion of effects, which was 
the responsibility of Panel Number One, was thoughtful and disci- 
plined. It concentrated on the impact of Section 102 on corporations 

of different sizes and types, and in different in- «.*«.. 

. „. , Fact-finding 

dustries, with some spill-over into effects on the 

economy generally. It avoided any effort to pro- 
pose policy, except for a recapitulation at the end of the suggestions 
and ideas that came out of its own discussion. Those ideas and sug- 



gestions are turned over to this panel, merely by way of a legacy, for 
you to do with as you see fit. 

Now comes the discharge of your own assignment, which is that of 
reaching conclusions and recommendations. 

I have compiled experimentally a catalogue of the various pro- 
posals — either as to law or administration — that I have seen for the 
modification of Section 102. I haven't limited myself in that catalogue 
to suggestions that were passed over by the other panel. We're wing- 
ing on our own now, and we want ideas, whatever their source. We 
want to be sure that our canvass of the possibilities is thorough. 

It is my suggestion that we use such a catalogue as the one that I 
have here — not necessarily this one — as a framework for our discus- 
sion, in order to keep it orderly. In that event, I assume that our 
proper procedure would be first to scan it, and 
second to amend, delete, modify, or add to it as 
we see fit, until we have a document that satis- 
fies us. Thereafter, we would be bound by it, and each discussant 
would refer by number to the proposition, or cluster of propositions, 
to which we were addressing ourselves, for the purpose of enabling 
the management to build up a compact record in the end. 

The feasibility of such a record I think was attested by the topical 
index of the questionnaire material and of the discussions of the 
preceding panel. 

There is one proposal that you will not find in the list. It exists, 
however, and it can always be invoked by anyone who wants to do so. 
That is, to do nothing. I suppose the positive phrasing of it would be 
to approve the law and the Bureau's administration of it, as they 
stand. We could regard that as the unnamed option. That's Proposi- 
tion X. 

Discussion of Panel Procedure 
Mr. Gainsbrugh: I take it from what you've said so far that our 
assignment is to develop a body of conclusions and recommendations. 
Are we, as members of this panel, bound to the policy recommenda- 
tions that are made in our capacity as individ- 
Panel Members cr ^^ ^ ^ re p resentat j ves f our organizations? 
in Personal Capacity J£ ^ ^^ ^ j for ^ wouW be ^ a 

somewhat difficult position, because the Conference Board takes no 
position on legislative matters. We refrain from advancing policy rec- 
ommendations for legislative purposes. I am assuming, unless cor- 
rected by the representatives of the Tax Institute, that no organiza- 


tion is bound here by the opinions expressed by any of its representa- 
tives who happen to be on the panel. Now, is that correct? 

Mr. Richardson: It's an expression of personal views. In other 
words, everybody is here in a personal capacity. 

Mr. George: Everybody is here in a personal capacity. 

Mr. Richardson: Well, is it not also true that the Tax Institute 

itself is not bound by any conclusion reached? _ , . L . , L 

_ ,,'•..', . . r Tax Institute Not 

Even though it miernt represent a unanimity 01 _ . . - , . 

. . ■ , ° , . , , T . Bound by Conclusions 
opinion here, it does not bind the Institute to 

support it, as I understand it. 

Mr. George: I'm sure that's true, although it would go beyond any 
interest of ours today. We come out with whatever we come out with, 
and thereafter it is up to the Institute to determine what use they 
wish to make of it. 

I would raise a question, though, that is a little premature, but I 
think it has to be met. As I say, our assignment and our duty is to 
arrive at conclusions. We're not here, as we just agreed, as representa- 
tives of any organization. We're here as individuals. 

How do we arrive at a consensus? In what way do we determine 
our conclusions? By vote, or simply by recording the sentiments of the 
individuals, which will thereafter be analyzed and weighted by the 
management? Are there precedents for this? Miss Walker, is there any 
procedure usually followed? 

Miss Walker: The previous Capital Gains Taxation panel is the 
only one that we have completed prior to this. There was an in- 
formal agreement reached at the end, a broad general agreement, to 
the effect that capital gains taxation should not be abolished, but the 
consensus of the participants seemed to be that adjustments should 
be made in a tapering of periods and rates, rather than outright 
abolition. We didn't try to get anything more concrete and specific 
than that. 

In this case, it will probably be desirable to try to get something 

more definite since this group is concentrating on policies. But there's 

no reason why there has to be any limit on the M . 

views expressed. It would be better to have each 

1 . . . ... Artificial Unanimity 

person present his own views, even 11 it means 

that there are no two people who have quite the same view. We 

wouldn't want to smother any individual opinion in order to get an 

artificial agreement. 

Mr. George: Well, I take it, events will determine the extent to 

which you can have unanimity on any proposition, ranging from 


broad to specific. What I was not sure about was whether you gentle- 
men cared to call for a showing of hands on each point. Suppose we 
reserve the question until there's been some discussion, and until we 
see how the distribution of opinion shapes up. 

Mr. Austin: Well, I think that you would do better by saying that 
you had a majority vote on any given proposition. I think you'd pro- 
duce the most values on each phase of this discussion, if we could say 
that the preponderance was this way or that, or at least that views were 
expressed on one side, and opposing or alternative views were ex- 
pressed on the other. 

Mr. George: You would not put any stress on preponderance, but 
it's there. Where there is a preponderance it should be recorded. 

Mr. Austin: Naturally. 

Mr. George: Well, that's about all I was looking for. 

The whole record of the discussion will be available. I believe that 
is the intention, is it not, Miss Walker? 

Miss Walker: Yes, the whole record will be published. 

Mr. George: Participants will have an opportunity to read and 
revise the manuscript. 

Miss Walker: You will also have an opportunity to read proof, to 
change your statement as you see fit in the proof, or to add notes. 

Mr. George: I might also put it negatively. The matter of safe- 
guard lies entirely in your own control. You'll see the record, and 
you can eliminate anything that you see fit. But we don't want to 
lose the benefit of your knowledge and views. 

Miss Walker (in response to a query from Dr. Slitor): We felt that 
we wanted the Treasury represented here, so that if some proposal 
didn't seem feasible from the administrative point of view, then we'd 
like to have it pointed out. 

Mr. George: Yes, certainly the purpose is not to entice the Treas- 
ury into an unplanned statement of opinion on this question, but I'm 
sure that everyone present has a great interest in the advice of the 
Treasury on the technical questions that will arise. 

First of all, of course, you're free to express an opinion on whether 
or not you think the procedure itself is the most practical one. 

Digest of Proposals for Revision of Section 102 Submitted for 
Consideration of the Panel 
A. Procedural (Sources Indicated in Parentheses) 

1. Clarity 

a. Is it possible and desirable for the Bureau of Internal Revenue to stip- 
ulate more exactly the conditions or purposes that will justify heavy re- 
tentions under Section 102, and those that will not? (Fact-Finding Panel) 


b. Would it be safe for government or some other agency to conduct a 
campaign of education for corporate managements as to the justifiable 
bases of accumulation under 102? (Fact-Finding Panel) 

c. Can the extent of personal director liability in the event of penalty be 
further clarified? 

2. Internal Review 

Should a proposed 102 deficiency be approved by a special section of the 
Bureau at Washington before the taxpayer is called upon to defend his 
position? (Fact-Finding Panel) 

3. Timing 

Would it be feasible and desirable to allow corporations to satisfy the 
requirements of Section 102 by additional dividends paid within two and 
a half months after the close of the fiscal year? (Fact-Finding Panel) 

B. Criteria for Legislative and Administrative Rules 

1. Legislative (or Administrative) Limitation of Area of Challenge or Penalty 

a. Would it be feasible and desirable to redraft Section 102 so that it would 
require consideration and policing of only those corporations whose 
dividend distributions need to receive the attention of the government? 
For example, should 102 be made applicable only to relatively close 
corporations not mainly engaged in operating business? Is arbitrariness 
better than discretion in large areas of business Where fear and uncer- 
tainty are kept alive by 102 out of all proportion to the number of prob- 
able violations as the law is construed? (Fact-Finding Panel) 

b. Should an accumulation of 30 per cent in any one year be exempt? (Fact- 
Finding Panel) 10 per cent, 20 per cent, 30 per cent? (Thomas Tarleau 
and others) 

c. Should use of 51 per cent of the accumulation within three years relieve 
the taxpayer from challenge? (Fact-Finding Panel) 

d. Should an exemption of $100,000 of earnings be allowed in assessing a 
102 penalty? (Fact-Finding Panel) 

e. Should the penalty tax rates be reduced by half? (Fact-Finding Panel) 

f. Should the penalty under Section 102 be applied only to the unreason- 
able part of the accumulation? In that case should the rate of penalty 
be increased? (Fact-Finding Panel) 

2. Evidence 

a. Timing 

(1) What about the "immediacy" issue under Section 102? Should busi- 
ness be allowed to accumulate (against a period of depression, par- 
ticularly) if its records show substantial use of its earnings over time 
for maintenance of employment, stabilization of dividends to offset 
fluctuating sales, for intermittent expansion or intermittent develop- 
ment of new products? And over how much time? (Fact-Finding 

(2) Would a longer statute of limitations be warranted as a means of 
extending the period within which use of accumulations could be 

(3) Would it be feasible to average accumulations over time in deter- 
mining the allowable proportions of earnings retained under Section 
102, and over how long? Two, four, five years, or over what period? 
(Fact-Finding Panel) 

b. Purpose of Investment 

Should the right to invest be inviolable if the investment is related 
to the business of the taxpayer? (Fact-Finding Panel) 


C. Burden of Proof 

1. Is it desirable that the Policy Panel should take any position on changing 
the burden of proof under Section 102? (Fact-Finding Panel) 

2. Two principal objectives: first, to impose a penalty tax on the whole undis- 
tributed Section 102 net income where the Commissioner is able to carry 
the burden of proof; second, in borderline cases, to impose a tax on only 
the portion of Section 102 net income which is unreasonably accumulated, 
placing the burden of proof on the taxpayer but giving him the opportunity 
to make a distribution and abate substantially all of the tax. Under this 
proposal the penalty would be 50 per cent of the whole undistributed Sec- 
tion 102 net income where the Commissioner carried the burden of proof. 
In the borderline cases the taxpayer would carry the burden (a) of estab- 
lishing that its accumulations did not exceed the reasonably foreseeable 
needs of its business and (b) of proving the amount of the undistributed 
Section 102 net income that corresponded to those needs; the penalty would 
be 77 per cent of the accumulation in excess of those needs, but a credit 
of 90 per cent against the amount of the deficiency (established in one of 
several ways) would be allowed if the taxpayer distributed the amount upon 
which the determined tax was based (less subsequent dividend distributions 
in excess of Section 102 net income) within ninety days of the filing of 
notice. (American Bar Association. Details to be supplied in discussion.) 

3. The law should be amended to create a presumption that in the case of 
operating companies, profit accumulations are reasonable unless the Treas- 
ury shall prove the contrary. The unreasonableness of the accumulation, 
once established, however, should continue to be considered proof of pur- 
pose to avoid tax unless the taxpayer shall prove the contrary. (Committee 
for Economic Development) 

4. Amend Section 102 either (a) to place on the Commissioner of Internal 
Revenue the burden of proving that the corporation is improperly availed 
of; or (b) to limit the imposition of the penalty to corporate earnings in 
excess of some stated figure. (Laid before Governmental Advisory Board) 

Mr. George: I would like to make two observations. Under B 2 a (1), 

the immediacy issue, you'll notice a phrase that's in parentheses: 

"against a period of depression, particularly." The parentheses were 

supplied by myself: in the original text they 
Comment on , . ... 

weren t there. So the effect of putting: in the 
Proposals . „ , r . 

parentheses is really to make two questions out 

of one. Some may wish to consider a special case made for this sugges- 
tion, if the purpose is to provide against depression. Others may not 
consider such a special purpose necessary, and may look upon the 
question as complete without that phrase. So that the parentheses are 
put there merely to indicate that you can read it either way. 

Notice that, throughout, some of the proposals do not actually fol- 
low the plan of organization severely, and the reason for that is that 
sometimes the propositions were coupled. They were made interde- 
pendent, and I felt that I had no choice. I had no right to break them 
up, and put them in separate parts under their own headings, because 


in that case, those responsible for the proposals might not have as- 
sented. So you will find some confusion on that account. 

Now, the next question. Does anyone feel that this is a proper basis 
of discussion, and then what changes should be made in it? 

Mr. Austin: Is it your idea that we proceed in this order, piece 
by piece, down the line? 

Mr. George: No, I wouldn't bind anyone to that. It's simply that 
panel members would indicate the type of proposition to which they 
were addressing themselves, by the numbers, so that it could be picked 
up in the record afterwards, because everyone will be interested in 
different proposals. 

Mr. Vickrey: I don't know if I am out of order in suggesting it, 
but to my mind the big basic issues, with the exception of one or two, 
are not met merely by modification in the appli- New Appr0Qch Moy 
cation of Section 102. We should examine Needed 

whether a mere revision of Section 102 or some 

new approach to the subject is needed. I don't know whether that is 
under discussion at this time. 

Mr. George: I see no reason why not. If you have a suggestion to 
make the group will consider it. 

Mr. Vickrey: Well, I have two or three rather drastic revisions to 

Mr. Slitor: You mean some basic revision of the corporate-individ- 
ual tax structure to integrate the two taxes? 

Mr. Vickrey: Well, that or something on the order of an annual 
low-rate tax on surplus. I don't know whether you want me to elabo- 
rate on that, or not. 

Mr. George: This is the time to register ideas. Would you mind 
repeating yours, Mr. Vickrey. 

Mr. Vickrey: I suggested this four or five years ago: an annual tax 
of two or three or four per cent, on that order of magnitude, on the 
aggregate cumulative surplus of all corporations, . . _ 

to represent an appropriate interest charge on 
the tax which is being deferred by the stock- 
holders, by reason of retention of the earnings in the corporation. In 
effect, this is a kind of undistributed profits tax, but it is a kind that 
is quite different from the 1936-39 variety. 

Mr. George: Would you indicate the major differences? 

Mr. Vickrey: The major difference is that this is assessed annually 
at a low rate on the aggregate accumulation, instead of at a high rate 
on the amount accumulated within the year. That is, if the corpora- 


tion has been accumulating it for ten years, it will have paid each 
year 2 per cent on that accumulation, until such time as it is dis- 

Mr. George: Well, does anybody wish to comment on the sugges- 
tion that this be added to the list. We're not trying to discuss it now. 

Mr. Austin: I think we ought to add it. 

Unidentified Speaker: Surely. 

Mr. Austin: I think what that amounts to is adding to the list any 
radical proposals from an entirely different approach to the subject. 

Mr. George: That's right, but I see no reason to bar any proposal 
until the possibility of considering the sheer bulk gets out of hand. 

Unidentified Speaker: By no means. 

Mr. George: Well, then, maybe everyone should add Professor 
Vickrey's proposal to his list. The way I have it set down here is: 
Assess an annual tax of 2, 3, or 4 per cent (at least low level) on the 
aggregate accumulated surplus of all corporations. I don't think we 
need to bother about that at the moment. We can just add it as a 
supplement, work it into the organization later. 

Mr. Vickrey: Well, I take it that something on the order of re- 

a G . vision of the capital gains assessment is out of 

. order. My approach would be to say, as Henry 

Simons does, that if an adequate assessment of 

capital gains is available there's no reason to have Section 102. 

Mr. George: There's nothing out of order, if it's applicable. The 
only reason I hesitated was that the Institute has already had a panel 
on the capital gains tax, and I wonder if, with the limited time at our 
disposal, we could be using it better on other matters. 

Mr. Vickrey: I think you're right there. 

Mr. George: As a matter of fact, I would like to go on record 

myself as saying that I always have a great distaste for approaching 

_ , , any of these tax problems in isolation. This tax 

Fundamental . . , . , 

. . , in particular is merely a patch that s trying to 
Re-examination of /. -, 1 , 

hold the rest 01 the law together, and any 

Tax Structure . _ _ . & ' , , ; 

proper approach would require us to undertake 

a fundamental re-examination of the kind of tax structure we want. 

Obviously that's out of the question, so that for the moment we have 

to limit ourselves to the purpose of this tax in the kind of structure 

we have. 

Any other suggestions about a change, or addition, or deletion, to 

the list? 


Mr. Vickrey: The only other one is to raise the question of whether 
Section 102 should not be deleted, regardless. 

Mr. George: I already mentioned the fact that that was a sort of 
spectral proposal in the background that anyone Possible 

could invoke any time he wants to. But there Recommendation of 
was hardly much point in putting it down in a ^^ or 0utrjght 
list of substitutes. Approya| 

Mr. Connolly: Mr. Chairman, I do not know 
whether I understood Mr. Vickrey. Did he say delete it or repeal? 

Mr. George: He said delete it. 

Mr. Connolly: Well, I do not think that's what you said, Mr. 
Chairman. I understood you to say that we approve it, as is. 

Mr. George: You're correct. I'll couple those. They're in the same 
category, as far as I'm concerned. 

In that case I think that the preliminaries can be regarded as closed, 
and we ought to plunge into the discussion. 

Mr. Gainsbrugh: Mr. Chairman, can we assume that there is fair 
agreement among this group on the objectives and purposes of Sec- 
tion 102? Mr. Vickrey's suggestions are aimed objectives of 
primarily at the point of the distribution of Secfion 1Q2 
retained profit. How far afield do we go in pro- 
posing alternatives? Where do we stand on purposes and objectives of 
today's discussion? 

Mr. George: Well, are you suggesting a distinction, for example, 
as between taxing accumulations as such from a standpoint of social 
policy, or the literal purpose of the present provision, which is to 
prevent the avoidance of surtaxes? Do you make your distinction like 

Mr. Gainsbrugh: I'm trying to get at the unstated assumptions, as 
well as the stated purpose of Mr. Vickrey's proposal. 

Mr. Vickrey: Well, might I clarify my proposal a little bit there? 
The purpose was not specifically to encourage distribution of surplus, 
but to make the tax laws more nearly neutral as between accumula- 
tion and distribution. That is, as the tax law Unneutrality of 
stands, at least without Section 102, there's been Tqx l ^ 
fairly heavy tax pressure in the direction of ac- 
cumulation. Would it not be there, if Section 102 were not there, over 
and above whatever other motives there might be for accumulation? 
And the purpose of my proposal, though it does not accomplish that 
purpose perfectly, would be to restore the status quo ante tax, as 


regards distribution versus accumulation. That is, the purpose would 
be to adjust this rate so that by and large, on balance, the motives 
would be about the same as without the tax. 

Mr. George: I am anxious to get into the questions — as I know is 
true of all of us — because we have a lot of ground to cover and we 
want to do it today. But perhaps the distinction is an important one, 
and I'd like to take just one more look at it. 

Are you looking at that subject from the standpoint of the effects 
on the entire economy? That is, do you want to tip the scales slightly 
further, as to corporate activity as a whole, in favor of distribution as 
against accumulation? 

Mr. Vickrey: As compared with the present law, yes. As compared 
with the situation in the absence of the tax, no. That is, I would like 
to reach a situation where the tax law is in such a state that the 
decision of management as to whether to distribute or not would be 
made on approximately the same basis as though there were no tax. 
That is, the existence of the tax as a motive should be removed as far 
as possible. 

Mr. George: Of course, the application of this tax, circumstan- 
tially at any rate, has been rather narrowly limited, which is one of 
102 L' t d ' t ^ ie reasons wn Y * asked you if you were trying 

. . to effect a general change in the economic policy 

of the country. Because it wouldn't have that 
effect, as long as its instrument is this tax. 

Mr. Vickrey: I'm not quite sure that I understand. 

Mr. George: I mean, the application of this tax is limited in prac- 
tice, so that it would not have broad economic effects of the kind 
you're suggesting. 

Mr. Vickrey: Quite right. 

Mr. George: So, in view of that fact, how far did you want to 
press the point? 

Mr. Vickrey: I merely was suggesting that that attempt to restore 
the balance should be on a broader front, and, of course, Section 102, 
where it does apply, ordinarily goes too far, on its narrow front. 

Mr. George: Yes, I see your point. Martin, on yours, I don't think 
it's within our discretion as a group to debar any line of analysis. I 
think it has to be left to the discretion of the individual, as the dis- 
cussion moves around the table, as to whether he wants to enlarge the 
scope of our thinking. 

Mr. Gainsbrugh: I am not averse to broadening our horizon, if 
time permits, to take in other goals and objectives, directly or indi- 


rectly related to this form of taxation. I do think it wise to bring it out 
into the open early, because as we go through Contra-Cyclical 
this outline we see that not only is the question Operations 

of avoidance of surtax mentioned, but also, let's 
say, contra-cyclical operations of the federal government. 

Mr. George: Well, of course, the point there is, as is the case with 
so many taxes and with so many public measures, that the original 
purpose was a very clear and narrow one, and ^^ ^^ Ryn 
has economic effects running beyond that pur- Beyond purpose 
pose. Now, the question that you're raising, as I 

see it, is how fully we shall recognize the overlap beyond the original 
purpose of the tax. I think again it's up to the individual to do as 
he sees fit. 

Mr. Duiker has been rendering public service recently in serving as 
Chairman of a Committee of the American Bar Association on Section 
102. The proposals with which his committee emerged have been ab- 
stracted by me in the list of proposals that were distributed. In fact, 
you'll find that on the outline under C 2. I'm going to ask Mr. Duiker 
to present the case himself, as a way of opening discussion. 

Statement by William J. Duiker 

Montgomery, McCracken, Walker if Rhoads, Philadelphia 

As a preliminary matter I should state that the problem has been 

approached, so far as the Committee of the American Bar Association 

is concerned, from a completely practical standpoint. Because we are 

actively engaged in the practice of law and make Practical 

our livelihood from it, we should like to have , 


at least some degree of certainty in our tax law. 

The present section gives us very little of that. It imposes subjective 
tests which generally are difficult to apply, and in addition we do 
not believe that the section operates fairly. It creates unnecessary fears 
in the minds of business people and often it is quite impossible to 
give a sound legal opinion on the question of the unreasonable accu- 
mulation of surplus. 

It may be proper to give you a short history of the activity of the 
American Bar Association with respect to Section 102. There was no 
considerable enforcement of the section during American Bar 

the war period and it was not until 1947 that Association 

the Bar Association created a committee to give Committee 

specific attention to this section. This committee 
was headed by Mr. J. S. Seidman and there were only two or 


three members on the committee. It worked quite actively although 
the suggestions proposed were not approved by the Section on Taxa- 
tion. Its principal recommendation was that a corporation which had 
distributed at least 50 per cent of its earnings should be relieved from 
the 102 tax. 

A small subcommittee, of which I was chairman, continued the con- 
sideration of the section although no concrete suggestions were sub- 
mitted. Larger committees functioned during 1948 and 1949 and it 
was only recently that this committee met in open sessions in Wash- 

The committee was given the opportunity of considering and ap- 
proving either a rather drastic amendment of Section 102, which I 
shall outline in a minute, or of recommending, without the need for 
legislative action, administrative changes which might eliminate some 
of the disadvantageous features of the section. The redraft of Section 
102 which was submitted to the committee was based upon the pre- 

Burden of Pr f m * se tIiat t ^ ie * ssues presented in the unreason- 
. T E . able accumulation of surplus can be divided 

between those which fall rather obviously in a 
classification of more or less deliberate evasion, and those which con- 
tain strong elements of good faith and the exercise of reasonable busi- 
ness judgment. To meet the problem head-on the redraft creates an 
election to be exercised by the Commissioner. If the Commissioner 
feels assured that he can establish that the predominant purpose in 
the retention of earnings was to avoid surtax on shareholders, the 
penalties remain substantially as they are in the present act, except 
that the burden of proof is shifted to the Commissioner. This is done 
because if the issue involves inherently the evasion of tax, the in- 
creased rate on all of the undistributed 102 income should be regarded, 
as it is, in the nature of a penalty and the Commissioner should carry 
the burden of proof. 

The second election has to do with that type of case in which, be- 
cause of the fair exercise of business judgment, the predominant pur- 
pose was not the avoidance of surtax. The committee believes that in 
c ii- situations of this character procedures should be 

D . , . set up for the purpose of determining what part 

Business Judgment l . .f ° r 

or the earnings, if any, had been unreasonably 

accumulated and the penalty tax limited to the amount so retained. 
The burden of proof in cases of this character is placed upon the tax- 
payer as it is in the case of the determination of all issues of fact as, 
for example, the question of reasonable compensation. 


If it is ultimately determined that a part of the earnings retained 
were not reasonably needed in the business, then an additional tax 
at a recommended rate of 77 per cent is imposed upon such portion 
of the earnings. This rate was determined upon for the sole purpose 
of forcing a distribution to shareholders. The purpose of the law has 
always been to impose a fair tax on shareholders. The corporation, in 
order to avoid the payment of this additional tax of 77 per cent, may 
elect to distribute that part of its earnings determined to have been 
unreasonably retained. In that event the tax will be avoided, and its 
incidence will be shifted to the shareholders, where the tax, but for 
the unreasonable retention, would properly have fallen at the rates 
in effect in respect to each shareholder in the year of distribution. In 
this way the ultimate purpose of the law will have been achieved in 
cases where evasion has not been established as the predominant pur- 

The committee members were asked directly to express their ap- 
proval or their disapproval of this proposed re- Burdgn rf proof 
draft of Section 102. At the same time, in case 
they felt that the proposals were too drastic, they were asked to give 
consideration to the following suggestions: 

If you are opposed to the suggested redraft of Section 102 do you favor: 

1. Placing the burden of proof on the Commissioner in all cases? 

2. Limiting the burden as provided in H. R. 6712? 

3. Allowing the burden to remain as now provided? 

4. Limiting the requirement of proof by a clear preponderance of evidence 
only to such cases, let us say, where there are less than ten shareholders, or where 
the majority of the control rests with those directors who benefit substantially by 
a nondistribution; or to cases where the Section 102 tax would be in excess of 
$100,000 or some other sum? 

5. Eliminating the requirement that proof by the taxpayer consists of a clear 
preponderance of the evidence? 

The committee was also asked whether it would favor an amend- 
ment which would provide that the tax be levied only on that part 
of the earnings which is ultimately determined to be unreasonably 
accumulated, and whether it would favor this 
amendment if the tax on the entire 102 undis- . . 

tributed income were to be levied only in cases ^ ^atTon Only 
where it was ultimately found as a fact by a 

court that the predominant purpose was the avoidance of surtax on 
shareholders, and, if so, whether such tax should be paid in lieu of 
the present penalties. 

The committee also was asked, since it is generally only the smaller 


. . ._. - . companies which are affected, and since Con- 

Limitation of Area L . . _ , . 

, . .. . gress is evidently interested in protecting smaller 

businesses, whether it would be in favor of 

amendments which would, let us say: 

i . Restrict the application of the section only to companies whose undistributed 
earnings were in excess of $100,000, or 

2. Whose net capital assets were less than $3,000,000, or 

3. Reduce the penalty in such cases, or 

4. Grant immunity for a period of years to new companies with a record of 

The committee was also asked if it believed that effective amend- 
ment is impossible at this time, and whether any of the foregoing 
objectives or others which may be devised could be secured by asking 
the Commissioner to: 

1. Outline in greater detail through published rul- 
Published Rulings ings reasons for the retention of earnings which, in his 

opinion, would avoid the application of the section. 

2. Publish a formula which could be used to deter- 
Formula mine the amount of liquid assets necessary for the opera- 
tion of the business and for credit purposes. 

3. Recognize reserves at current replacement costs, 
Reserves, etc. leveling of dividends, long-term expansion programs, pen- 
sion benefits or plans, etc. 

4. Establish a unit in the Bureau to which taxpayers 
. , _ .. could apply for rulings upon submission of balance sheet 

vance u ings an( j reasons ascribed for the retention of earnings with the 

requirement that the statute would not apply unless the 
Commissioner ruled adversely within seventy-five days. 

5. Limit the application of the section only to the 
Examination year currently under examination. 

6. Give special consideration to new businesses or 
Expansion small businesses or businesses with a record of expansion 

or dividend payment. 

7. Apply the section only in cases where there had 
Continued Violation been a continued course of violation running for more 

than two or three years. 

Full Details of ®" ^* ve s P ec i a l consideration to those companies 

. which in any year submitted full details of dividend dis- 

Distribution tributions to the Commissioner. 

The committee almost unanimously favored the more drastic ap- 
proach first suggested, of a complete amendment of the section. There 
are, in my opinion, sound reasons for the adoption of the amendment 
as proposed. It is, of course, almost universally recognized that a 
statute of the nature of Section 102 is absolutely essential for the 
sound administration of our tax law. Congress has always feared that 
taxpayers would use corporations as a shelter for the avoidance of 

Year Under 


personal surtaxes. This matter was discussed at length and vigorously 
debated when the Tariff Act of 1915 was first H[ ^ ^ 

under discussion by the Senate. As a matter of Legislation 

fact, this act and the Revenue Act of 1916 used 
the word "fraudulently" and thereafter substituted for it the less 
offensive phrase "availed of for the purpose of avoiding surtax." Gen- 
erally the history of the tax has been one of Treasury inactivity, and 
it has been Congress which has needled the Treasury into greater 
enforcement efforts. The Treasury's answer usually was that the sec- 
tion did not have enough teeth in it, and that it was impossible to 
secure favorable decisions from the courts. The Treasury got such an 
act in 1938 and it is that act which is causing the present difficulty. 

Certain conclusions can be drawn from the history of this legisla- 
tion. One, that in the opinion of Congress the unreasonable accumu- 
lation of surplus is either fraudulent or tainted with fraud. Another, 
that the ultimate object of the statute has always been to secure a 
fair tax from individuals whose source of income was derived in part 
at least from a corporate activity. Another, that the various devices 
designed to secure this end have, until the 1938 Conc|usions Drawn 
Revenue Act, proved ineffective, and another, from HJstQ 

that the present act is completely inappropriate 
to fairly achieve the ends desired. The redraft seeks to harmonize these 
views. The theory on which the statute is drawn is quite simple. The 
Commissioner may, in those cases in which he believes he can estab- 
lish as a predominant purpose the object of tax avoidance, proceed 
to impose the harsh penalties which are now provided by law. Since 
the substance of the charge is tax avoidance, he should bear the 
burden of proof as he is now obliged to do in other cases which in- 
volve tax evasion. He therefore possesses the same weapons which he 
had before in what he may deem to be flagrant cases. 

Where, however, as is so often the case, the degree of omission is 
minor or where business considerations may have been compelling, 
the way should be open to determine what a fair distribution would 
have been with the imposition of a fair and proper tax on the share- 
holders. The rate of 77 per cent has been set Smaller 
solely for the purpose of forcing such distribu- Corporations 
tion so that the tax shall rest where it should . 
have rested initially. The committee felt that 
the section should either be drastically revised or that complete re- 
consideration should be given to the taxation of small businesses. It is 
generally conceded that it is only the smaller corporations which are 


affected by Section 102. Many of these corporations are in dire need 
of tax relief. 

We are coming slowly to the recognition that the section as it stands 
has been responsible for adverse economic influences of far-reaching 
effect. It has precipitated hasty expansions, the unwise acquisition of 

... r assets, mergers, the sale of businesses to charities 

Responsible for ° 

. . r . or monopolies, liquidations, conversions into 
Adverse Economic ■ . . l 

„ ,. proprietorship forms, drastic curtailment of busi- 

Influences r r . r , 

ness operations, debt financing, the unwise adop- 
tion of pension or profit sharing plans, the increase of inventories, etc. 
I am sure that the fear of the 102 surtax together with fear of stock- 
holders' suits must, in the long run, have sharply deleterious effects 
upon our economy and upon latent enterprises so necessary to normal 
or healthful business growth. 

The committee felt upon the recommendation of the adoption of 
this amendment that its enforcement would not be too burdensome to 
the Commissioner, nor would it add too much to his administrative 

j . responsibilities. We submit that a minimum of 

Recommendation Not . . . . .-,.,. 

A ' . . . , administrative responsibility must be squared up 

Administratively . A . . ' , ■,,,.,., 

to in order to provide lair and workable legisla- 
tion. It would appear to be no more difficult for 
the Commissioner to determine what, in his opinion, should have been 
a reasonable distribution than it is for him presently to determine the 
reasonableness of compensation or the value of closely held stock or 
other provisions involving opinion tests. 

This amendment, subject to technical changes in the draft, stands 
now as a recommendation of the Committee of the American Bar 
Association although it has not as yet been submitted to the Section 
on Taxation for consideration. 

The committee also made a further suggestion, the need for which 
is imperative whether or not substantial changes are made in the law. 
All of the committee members feel that the courts have not given full 

recognition to the intent of Congress when in 
Reasonably , . & , . . , , & . 

, , . , , their decisions they make the test or unreason- 
Foreseeable Needs 

able accumulation of surplus depend upon the 

immediate needs of business rather than the reasonably foreseeable 

needs of business. We believe very strongly that the courts should take 

a longer view of the need for surplus and that the present immediate 

tests now being applied are contrary to the legislative purpose of the 

act. The committee felt strongly such an amendment should be pre- 


sented immediately regardless of the broader attempt to make the 
section more workable. 

Discussion of Statement by William J. Duiker 
Mr. George: What kind of treatment does the panel think these 

proposals should get? Who will offer a comment? 
Mr. Austin: I'll start if I may. 
Mr. Duiker, I am not going to try to deal with all the aspects of 

your proposals with which I may agree. Some of them I shall cover 

in my own principal statement. One of them 

7 r Immediacy 

I might mention briefly now. Thats the prob- 
lem of immediacy, which I think the proposals might meet. That is 
one of the most important problems we have in this field. 

It did strike me, however, that there was a question of practicality 
in this proposal, and that is this: the Commissioner is evidently given 
the alternative of assuming the burden of proof on whether there was 
undue accumulation, with one result: a 50 per cent tax on the entire 
accumulated earnings of the year; or, alternatively, of making a pre- 
liminary determination that a certain portion of the accumulation was 
unreasonable, and giving the taxpayer the burden of proof of showing 
that the contrary is true, with a different result. 

Now, what I'm not clear on, is, with such alternatives, why wouldn't 
the Commissioner, in any case, say that 5 per . 

cent, 1 per cent, 2 per cent, any negligible por- ^^ rf Rroof 
tion, is the only reasonable part of the accumula- 
tion, and then throw the burden on the taxpayer of proving that all 
the rest was reasonable, with a 77 per cent tax facing him? 

Mr. Duiker: We expect that will be true. We expect that it will 
throw a great many more cases into the field of dispute, simply be- 
cause of this fact. I think the administration of the law up to the 
present time has been quite fair. The Treasury has had quite a fair 
reaction to it. But it could change very rapidly. Now, we, as lawyers, 
would much rather be in a position of being able to litigate a number 
of cases, than meet administrative treatment, which became very 
radical, or very violent. 

Mr. Austin: What bothers me is this: I think it was the general 

consensus in the fact-finding group that one of ... . , . . . . , 
. , . . r . . ,. Would Multiply 

the worst parts 01 this situation is not its applica- 
tion to specific cases, but the fear it creates, the 

whole cloud that hovers over business policy decisions on the matter 
of distribution. 


Now, with this proposal, and the Treasury in a position of making 
an election which confronts the taxpayer with a 77 per cent tax on 
what could be virtually his entire accumulation, it seems to me the 
fear is multiplied three times over what it is now. 

Mr. Duiker: We think it will be almost entirely eliminated. 

Mr. Gemmill: Would it be possible for the Tax Court to find 
that more had been unreasonably accumulated than the Commis- 
sioner had determined? In other words, could he determine 1 per cent? 

Mr. Duiker: No, he shouldn't, because it's based upon a deci- 
sion. . . . 

Mr. Gemmill: Could the Tax Court then determine 50 per cent 
was unreasonable? 

Mr. Duiker: No, the Tax Court would determine whether or not 
the amount of the deficiency, based upon that, was correct. That 
would be the limit of its jurisdiction. 

Mr. George: Does that help clear up the point you were interested 

Mr. Richardson: No, no, not at all. Contrary to that possibility, 
Ken, in any instance where the Commissioner is making the decisions, 
logically he is always going to determine that the proper accumula- 
tion is 1 per cent, and the improper accumulation 99, no matter what 
his real feelings. He'd always put the proper accumulation at a very 
low percentage — 

Unidentified Speaker: I agree. 

Mr. Richardson: ... so that there would be a burden of proof 
on the taxpayer, who would be supporting 99 per cent of the accu- 

Mr. Gemmill: I have never thought that the approach to the 

burden of proof standpoint really got very far in this whole field, 

because when it comes to a question of actual litigation the burden 

„ . , ,«-,.. of proof usually falls by the wayside. The Corn- 
Burden of Proof Not . r . ; ; • •-, 1-1 
missioner can present certain evidence which 

will shift the burden of going forward to the 

taxpayer, and then the taxpayer is going to have to prove his whole 

case just as he would anyhow. Then the whole record is before the 

Tax Court, and I don't think burden of proof really has gotten very 


The principal point of changing burden of proof is to change the 

attitude of revenue agents, and people higher up in the Bureau, who 

deal with settlement cases. If they think they're faced with a hard 


job the administration won't be so bad. From an actual standpoint 
of litigation, I don't think the burden of proof is involved. 

Mr. Duiker: Well, what we were trying to reach, Mr. Gemmiil, 
was really this. I think you'll find a number of cases where the degree 
of violation is very small. In other words, as far as the Tax Court is 
concerned, the difference between a distribution of 20 per cent and 
30 per cent might throw the case against the tax- . , 

payer, and then he's got to pay a tax on the en- 
tire amount, whereas if the violation were very small, one corporation 
may have distributed 10 per cent and retained 90; another 50, when 
it should have distributed only 55, but would get caught on the 55, 
and yet it suffers a tax on the whole income. What we're trying to 
do is to throw the problem in the arena of litigation. 

Mr. Gemmiil: I agree with the objective, but I think the only 

way to accomplish it is, in any case, to have the _ _ , 

ii, -, -, a 1 Tax 0n, y 

tax apply only on the unreasonable part. As long 

as there's an election as far as the burden of 

proof is concerned, I don't think you reach that objective. 

Mr. Duiker: Well, we thought we ought to keep the teeth in the 
law. Congress has always wanted it in the law, and I think the Treas- 
ury does. So, we tried to retain for the Commissioner his ability, in 
those cases where there is a clear intent to avoid taxes on sharehold- 
ers, to make that penalty heavy and severe. 

I think we've got to have it in the law. That's why I think in some 

cases you've got to have a very severe penalty, but where there is an 

element of reasonableness involved, then I think 

_. . . . __, , . Want to Keep 

it ouffht to be litigated thoroughly. That s the - , . . 

t 1 r , . 1 j T 1 . 1 Teeth m Law 

whole purpose or this amendment, and I think 

it's on the right road. We haven't taken a thing away from the Commis- 
sioner, so far as the purpose is concerned in reaching the cases where 
there is a clear attempt to avoid taxes on shareholders. 

Mr. Gainsbrugh: I have one question I'd like to ask Mr. Duiker. 
I think there's great necessity for immediacy of clarity, in so far as 

Section 102 is concerned. Will your proposal 

Immediacy of 
lead to immediacy of clarity, or will it postpone . 

for some period of time, perhaps for a period 

of years, further clarity of Section 102? 

Mr. Duiker: Well, I would think that it would lend immediate 

clarity to it. I would think it would make my job and the job of 

most tax practitioners much easier. We could exercise a little better 

judgment about this thing without fear of inordinate consequences. 


I think it's administratively feasible, and I think it would give us 
a lot of clarity immediately. 

Mr. Gornick, may we hear from you. 

Statement by Alan L. Gornick 

Director of Tax Affairs, Ford Motor Company 

Mr. Gornick: If I read the fact-finding panel's report correctly, 

,, it found that the whole difficulty with Section 

Uncertainty . . _ ,' 

102, as it presently exists could be summed up 

in one word, "uncertainty." 

First, there's no certainty as to the application of the statute to any 
particular corporation. Secondly, there's no standard set for what may 
be considered an unreasonable accumulation, so there's uncertainty 
on that score. Further, there's uncertainty as to the use which can 
be made of retained earnings. In other words, can you reinvest them? 
The immediacy doctrine comes into play. And fourth, there is un- 
certainty as to the method by which the statute may be administered 
by any particular agent, anywhere in the country. 

It appears to me that these are the four principal elements that have 
been plaguing everyone dealing with Section 102 and its practical ap- 
plication, whether they're tax attorneys, businessmen, or economists. 

Looking at it practically, it seems to me that the solution of the 
problem lies principally in eliminating those fields of uncertainty, 
rather than changing the burden of proof in litigation, and so on, 
because after all, it's a very, very small number of cases that ever reach 
the point of litigation. In private practice, I handled a number of 
102 cases. I never tried a single one. The burden of proof element 
never entered into the picture. 

The principal difficulty that I encountered as a tax practitioner, in 

advising clients, was in this field of uncertainty. 

Principal Difficulty How to advise a client with reasonable certainty 
for Practitioners . .. . r . . 

as to the proper application of the statute is a 

practical problem. I believe that's the problem that's facing everybody 

today, as far as Section 102 is concerned. 

My own suggestion would be that we take a look at the four ele- 
ments of uncertainty that the fact-finding panel discovered in the ap- 
plication of the tax, and then determine, as a matter of policy, what 
we can do to eliminate them, without seriously jeopardizing the stat- 
utory purpose. 

The first uncertainty is to determine to what corporation the statute 
applies. The question, obviously, comes down to closely held corpora- 


tions against those that are publicly held. I think that field of uncer- 
tainty could be eliminated without impairing ' , 

1 .„ , , , Eliminate Publicly 

the statutory purpose if a rule were adopted that 

J L r r Held Corporations 

the statute would not apply in any case in which 

no one individual, or no intimate family group, controlled more than 
10 per cent, or 15 per cent, or some other percentage, of the stock- 
Obviously, the chance of a corporation being used to accumulate sur- 
plus to avoid surtax in that type of case is minute. 

Secondly, uncertainty presently exists because there is no standard 
set now for determining what earnings may be considered to exceed 

the reasonable needs of the business. Well, I , , „ , 

... , , ., , , . Blanket Rule for 

think wed all agree that no business can con- „ , , •, 

. ,. Reasonable Needs 
tmue to prosper or can go on by distributing all 

of its earnings. Certainly, I think the Treasury will be the first to agree 

that some accumulation is necessary, particularly in a business in 

which capital is a substantial income-producing factor, as opposed to 

one deriving income solely from personal services. 

That type of business should be permitted to retain some clearly 
defined amount of earnings, with respect to which no question would 
be raised. How much? Well, obviously, as Justice Holmes once said, 
you have to draw the line somewhere, and I would suggest that the 
great field of uncertainty here could be clarified by certainly adopting 
a blanket rule that the statute will never apply in any case in which a 
specified percentage, for example, 70 per cent of the earnings sug- 
gested in the Bureau's mimeograph, have been distributed, and on 
the average, over a period of five years, because that, I think, will 
permit — 

Mr. George: Seventy per cent on the average? 

Mr. Gornick: Seventy per cent, or some other stated percentage, 
on the average over a five-year period. Now, why do I pick five years. 
Well, in the first place, I think businessmen take a look and project 
their plans over a four- or five-year, or longer period. They don't do it 
over a one-year period. 

Secondly, from the Treasury standpoint, I think that there's always 
a lag in Section 102 cases. The question doesn't come up as respecting 
one year in that year, or the succeeding year. The lag is usually three 
to five years. This would then allow both the Treasury and the tax- 
payer to take a look over a five-year period. So I believe that that 
uncertainty about the amount that can be retained will be eliminated 
in a large number of cases by a provision of this nature, without 
serious jeopardy to the present income of the Treasury, and in all 


fairness to the taxpayers who distribute at least the 70 per cent men- 
tioned in one of the Bureau's releases which, incidentally, has led to 
a great deal of misunderstanding. 

Now, the next field of uncertainty referred to by the fact-finding 
panel, is the uncertainty as to what a corporation may do with earn- 
ings properly retained, for example, for expansion. Obviously, it may 
not be sound business judgment to spend all earnings in the first year. 
I think an excellent example is the situation as it has existed the last 
three or four years. Costs are terrifically high. It may be prudent for a 
businessman to invest the earnings temporarily, and carry out his plan 
of expansion when costs are lower. He should not be forced to purchase 
materials in a period when costs are high, simply adding to the in- 
flationary cycle that exists. I think that's what has happened in the 
last three or four years, and that that has been affected by the im- 
mediacy doctrine. 

Well then, we should, I think, prescribe some conditions or pur- 
poses — I think the Treasury could probably do it best by regulation 
— under which a retention of the accumulation 
reasury egu a ion ^.^ ^ e considered reasonable. In such a reg- 
ulation, it should be clearly provided that a tax- 
payer may, if he so chooses, invest the retained earnings pending the 
time that he expects to spend them for any planned expansion, or for 
any other business need for which they've been retained. 

Also, items like this could be definitely covered by regulation. One 
of them, for example, is: Can a corporation in one year pay up all 
past service liabilities under a pension plan, although it may not 
have an obligation to do so? The same thing on indebtedness. A 
corporation may have indebtedness maturing over a long-term period. 
Why shouldn't it pay off its indebtedness immediately if it has 
the funds to do so, even though there is no necessary immediate 
legal obligation to do so? Although the courts have held such ex- 
penditures to be entirely proper, nevertheless, questions like that 
plague a practitioner and his clients, and I think could be sub- 
stantially eliminated by regulation. 

Now, finally, we have the question of the method of administration 

by a particular agent, and all of us know that nobody can predict 

what an agent in San Francisco, or New York, may do. Their views 

may be entirely different. The human element is 

11 * '" involved. It's completely uncertain as to what 

decision some person, who in most cases has no 

knowledge of economics and still less knowledge of business, will make. 


Yet this man is given the responsibility of determining whether busi- 
ness has accumulated earnings beyond its needs. 

I think that Mr. Duiker's proposal might very well eliminate that 
field of uncertainty. In other words, the accumulation would be valid 
if made for reasonably foreseeable needs of the business, and in any 
event, 90 per cent would be abated if the taxpayer elects to distribute. 
The matter, however, to be finally determined, not by the agent, but 
by someone who is more competent to do so, and usually in a case 
where the distribution would be made under the election, would be 
pursuant to a determination, at least, of the technical staff, or, per- 
haps, of the Tax Court, which would eliminate any abuse of discre- 
tion by any particular agent. 

Discussion of Statement by Alan L. Gornick 
Mr. George: It seems to me that what has developed here is a 
pretty sharp distinction between two approaches: one is on the as- 
signment of burden of proof, and the kinds of administrative pro- 
visions that would go with different assignments, and the other, on 
the development of clarity in the administration of the law for the 
benefit of the people who have to live under it. 

I think more ideas of the same sort are going to tumble out on the 
table as we go around, so this is probably not the time yet in which 
to come to grips with a particular idea, and ask for opinion on it. So, 
I'm going to ask Mr. Duiker for a short response, and then we'll go on. 
Mr. Duiker: Well, I have a very brief response. I think it's all very 
desirable to get certainty in tax law, but I don't think we're going to 

eet it. I've been in the business too long. Second, „ . - , 
?,.,.,, , • , • 1 j r Certainty Impossible 

I don t think that legislatively you can draft ex- 
tensions, or draft legislation, which is going to eliminate the uncer- 
tainty, and still be faced with a heavy penalty on the wrong guess. 

The Treasury Department had already prepared a new regulation 
which they were going to promulgate, and then they changed their 
mind about it, because they thought that it would allay some of the 

fears that businessmen had, so it never got in , . 

, Treasury Regulation 

print. Another thing, you already have a regu- 
lation — a pretty good regulation, too — that you may retain money for 
the expansion of your business, and yet you have the World Publish- 
ing Company case, where they did retain it for expansion. They got 
hooked with a very heavy tax, because the court stepped in, despite 
the regulation, and said that they didn't need it to expand. 

I don't think words, or anything like that, will do any good. What 


I'd like to see is an opportunity where I can come to grips with the 
problem, and thrash it out on a fair basis, with a fair tax, without a 
penalty, where I've got some reason for justification. That's the thing 
that I think is much more important than certainty. You can't ever 
get complete certainty. 

Mr. Gornick: Well, now, I think you would admit that we could 
get more certainty than we now have. 

Mr. George: I wonder if we may pass at the moment. We'll be 
back to it again and again. 

Mr. Richardson. Mr. Richardson was Chairman of the Committee 
on Federal Taxation of the American Institute of Accountants, and 
he's given a great deal of thought to the question. Would you pro- 
ceed, Mr. Richardson. 

Statement by Mark E. Richardson 
Lybrand, Ross Brothers & Montgomery, Washington 

Mr. Richardson: I think that possibly I would like to make a 
rather brief general statement, and hold some of the comments, at 
least, until we discuss specific points. I think it will be easier for me 
to present a particular point of view on some of the things then. 

As far as consideration of any policy that is determined by a body 
important enough to receive attention is concerned, one thing that I 
think is vital is whether consideration, of itself, sanctions the basic 
premise of the thing being considered. Therefore, as we consider a 
policy that relates to Section 102, we must consider the effect of the 
acceptance of 102 in either its present form, or a suggested amend- 
ment to it. 

Now, I'm perfectly willing to admit to the need of something in 

the nature of 102, and the historical background 
Major Fallacy q£ .^ Bm j dQ think ^^ history has prove d 

in Section . . r ,, ., 

there is a major fallacy in the section. 

We have heard of, and the fact-finding panel found, a very lim- 
ited real application in court decisions. It also found the fear, the un- 
certainty, that Mr. Gornick mentioned, as being probably the major 
effect of it. To me, the reason for that is that we have a completely 
uncertain section in the law which sets against 
pp ica ion ^ e judgment of management the judgment of 
a group of people completely without the facts, 
until management can present them, because those considering the 
other side cannot know the considerations that went into a general 
policy determination. We offer to the taxpayer who gets an adverse 


decision by those inexperienced and unknowing — we offer to that 
taxpayer an alternative of giving in or going to court and under rules 
of evidence proving something that was very uncertain in his own 
mind to start with. 

So there is no place in our administration of 102 where a business- 
man, having made a judgment, can ask another businessman whether 
he was right or wrong. There is no other businessman passing on this 
judgment, anywhere along the line. The tax 

practitioner who attempts to help the taxpayer „ . 

rr 1 it ii-r • Businessmen 

must offer that help on the basis of experience ,, 

. l . . ; Unavailable 

m other tax cases, not experience in that par- 
ticular industry or knowledge of that particular company. So that a 
major fallacy rests in 102, in the whole administration of the section 
as I said, which I think must affect any decision on policy. 

As between the two points of view that I think are necessarily our 
prime consideration, I feel that they are not divergent in possible 
statutory change. I think that something along the lines of the recom- 
mendation of the American Bar subcommittee is very much justified 
and very much worth while. I do feel that, at the same time, limita- 
tions which eliminate the company to which Section 102 should not 
possibly apply because of size, both largeness and smallness, are per- 
fectly feasible. A corporation which is earning a small amount of 
money, and which, if it distributed its earnings, would distribute 
maybe to only five or six or ten stockholders, still is so small that it 
can have no effect on the revenues if it accumulates or doesn't ac- 
cumulate, and it shouldn't have the fear of 102 presented to it. 

Mr. George: I don't want to interrupt, but just to call attention 
to the fact that revenue would be only one of the objectives of this 
provision. There are equities involved there, among others. 

Mr. Richardson: Well, unfortunately, Mr. George, I have difficulty 
(having been involved in so many of these 102 considerations) in ac- 
cepting the theoretical equity that has been talked about so much 
in this section. I don't feel that it actually is there. I think that Section 
102 serves the purpose that it was intended to serve, which was to force 

distributions so that they could be taxed; that T1 . , _ . 

_ . . . ., • -r. • Theoretical Equity 

was the reason it was originally put in. But it 

serves so many unfortunate purposes at the same 

time that I think that any step — as Mr. Gornick pointed out — which 

eliminates uncertainty and eliminates some of the bad purposes served 

by the section is a worthwhile step. I feel that the change of burden 

of proof might well serve to eliminate the threat of the application 


of 102 which is one of the fears and the uncertainties that the tax- 
payer has. He knows that even if he isn't ultimately going to pay a 
tax, he's going to be threatened with it by an examining agent. Now, 
that threat can possibly be eliminated, or at least reduced materially, 
by a change of the burden of proof. The agent is not going to 
threaten the application when he knows that immediately above him 
somebody is going to say, "Well, you know we can't prove it, so let's 
not try to scare anybody with it." 

Mr. George: But, to keep the train of thought here, are you also 
accepting the suggestion of a divided burden of proof? 

Mr. Richardson: I have difficulty accepting the theory of a divided 
burden of proof. I feel that, in practice, it would result, as Mr. Austin 
pointed out in his comments, in the Commissioner's ducking his 

burden of proof and always putting it on the 
Divided Burden , r , . . / r & 

taxpayer by determining that a proper accumu- 
lation was a very small percentage and so elimi- 
nating that question of burden of proof. So that I don't think that 
really accomplishes anything. I feel that a complete change of burden 
of proof might — solely in the change of attitude on the part of agents, 
not in actual trial of the cases, where I do not think that it matters 

But I do feel that a combination of those two points of view is 
more than possible, that is, a change of burden of proof and some 

specific limitation that would automatically take 
Limitation of Area r , r A , t _ 1 _. 

a percentage of the fear away. And anything 

which takes some of that fear away is worth while in our economy. 

Mr. George: This, I assume, would be done legislatively? 

Mr. Richardson: I think so. 

Mr. George: And you would indicate — you would try and partic- 
ularize the types of corporations to which alone the provision is in- 
tended to apply — types of corporation, types of activity, special sit- 
uations — 

Mr. Richardson: Or rather, the ones to which it does not apply. 

I would rather put it on that side, of specific nonapplication within 

certain limits. And the only reason that I think that statutory change 

would be necessary, Mr. George — you see, as 

reasury ^ as ^^ pointed out, as Mr. Duiker pointed 

" out himself — is that the Treasury has several 

times considered new regulations, and it has, over thirty-five years, 

had time to write new regulations if it wanted to. And it just doesn't 

want to. 


Now, experience has certainly proved that if we say, "Well, now, 
you can help us by writing some new regulations," we're saying the 
same thing that we've said for twenty years and we'll get the same 

Mr. George: Isn't it worth while at this point to try to be a little 
more specific as, to the types of corporations to which the provision 
would not apply, so that we would be talking in common terms and 
not merely about an abstract idea? 

Mr. Richardson: I'd be glad to, if you wish. I was keeping it de- 
liberately abstract to indicate a point of view without restriction on 
it at this time. 

Mr. George: Well, I think that's correct, but in the end, there 
could be no action unless the people are talking about pretty definite 

Mr. Richardson: I do feel that practice has indicated that many 
really small corporations, corporations earning up to $25,000 of in- 
come—it is not fair to call them small in the over-all picture, but 
small as they turn up in practice — are worried about this problem. 

Now, in this theoretical equitable approach to the problem, maybe 
they should have to worry about it, but this is part of a revenue law, 
and if it's done to protect revenue, I don't think $25 Q00 Minjmum 
that that corporation should even be in the pic- 
ture. I would say that some minimum, certainly down to the $25,000 
figure, should not be considered. I'd rather see it at a higher figure. 

Mr. George: All right, that's one suggestion. 

Mr. Richardson: Certainly, I don't think Section 102 should ap- 
ply to the corporation, as Mr. Gornick points out, in which no indi- 
vidual or family group can control more than Basjs rf Contro , 
10 per cent or 15 per cent of the stock under any 
statute, no matter what the size of that 10 per cent might be in dollars. 

Discussion of Statement by Mark E. Richardson 

Mr. George: Well, that would really take in the huge area of big 

Mr. Richardson: Yes. 

Mr. George: Eliminate it at one swoop. 

Mr. Richardson: And I think that it should. 

Mr. Slitor: In practice, is there a great deal of uncertainty in that 
area? How much uncertainty do you think that particular suggestion 
would eliminate? 

Mr. Richardson: I don't think what might be done should be 


measured by what is the area in percentage. I think that anything 
that can eliminate the uncertainty, any amount of uncertainty, should 
be done — because it is the uncertainty in 102 that causes 90 per cent 
of the difficulty with it. 

Mr. Slitor: Uncertainty is an inherent part of a provision of law 
which is designed to function flexibly. 

Mr. Richardson: That is true. 

Mr. Slitor: And when you eliminate uncertainty, you're eliminat- 
ing flexibility, which is one of the major merits of the section as it 
stands, and is the reason why, historically, it has stayed as it is. If a 
corporation operates in good conscience, I think 

_, ..... that the uncertainty is very minute. You can 

to Flexibility , { ._ 7 

get a better perspective if you consider the small 

number of cases historically that have arisen and the relatively small 

amount of tax that has been collected under the section over its 

entire history, including the period prior to 1934 in which there was 

no personal holding company provision. 

Mr. Richardson: You cannot measure what has happened in the 
dealings between agents and taxpayers — and that's where the fear and 
uncertainty exists. You can't specifically measure that. 

And there have been a number of cases where the agent has said, 

Threat by Agents " If 7 ° U ^^ giVe UP ° n ****' Tm g ° ing t0 gCt 
after you on 102." 

I wonder, Mr. George — I hate to do this, but it specifically answers, 
I think, that particular point. Take the following case: 

Mr. George: One case and the opinion, to the extent to which you 
think it is representative? 

Mr. Richardson: Correct. A corporation. The majority of the 
stock held in trusts. The beneficiaries of the trusts charitable organiza- 
tions, educational organizations. No individual stockholder or family 

group owning more than 22 per cent of the 

Case History , ■ r 1 • * 1- j 

stock of the corporation. An agent threatened 

102. Then, because he moved up to the conference section and super- 
vised the agent who subsequently followed him, convinced that agent 
that he could support the finding. It is now before the technical staff — 
in a circumstance where anyone with whom you might talk, including 
those in the Treasury in Washington, would say 102 shouldn't apply. 
The threat carried up in that particular case. But that type of threat, 
in order to get something else which the agent wants to get in that 
case, is prevalent in at least — and this is personal experience and it 
can't be supported with statistical data, again — but that sort of threat 


appears in at least 25 per cent or 30 per cent (and I think that's a 
very small percentage) of the number of cases in the field. The threat 
of 102 where there's something else that an agent wants to get deter- 
mined in his favor, appears in 25 per cent of the cases of an agent's 
examination in the field. 

And your statistical data ultimately show nothing because there 
isn't going to be any case, and there's going to be no collection of the 
tax under 102, but the threat was used. It has caused uncertainty. 
And each one of the individuals involved in that corporation will, 
from now on, have five or six years of worry and uncertainty about 
Section 102. 

Mr. George: Might I make this comment? We are on fact-finding, 
as you say. The point was raised and you wanted to give a specific 
illustration immediately. As I recall, one of the findings of the fact- 
finding panel, upon which there seems to be 
fairly general agreement, was that the amount of 
revenue itself collected was not so significant as 
the amount of distributions that were made without regard to threat 
or any other special consideration of that sort — simply because of 
uncertainty and the fear of the law. Perhaps they should have been 
made, and perhaps they should not. I'm not able to pass on that. But 
the point is that the revenue is small in comparison to the distribu- 
tions that were made because of the law. 

Mr. Austin: I'd like to come back to a point that Mr. Slitor started 
with. I think he started on one thing and the discussion got off on 
something else. 

I think I have the same point of view he has in regard to the matter 

of trying to exclude certain types of corporations from the operations 

of this section, and that is this: You are effecting on the one hand the 

exclusion of corporations with a sufficiently large _ . , 

1 Suggestions Leave 

distribution of shareholders. I think, the illus- .. . . , 

. Major Area of 

tration to the contrary notwithstanding, the ap- 

plication of Section 102 to those cases is almost 
nonexistent anyway. And, of course, on the other side of the scale, 
there's no doubt that you can relieve a large area of uncertainty in 
very small corporations by the flat statement that you take them out 
of the picture. 

But the big problems of 102, by and large, are not in the $25,000 
class. They are in the $50,000, $100,000, or $200,000 and $300,000 an- 
nual earnings classes. So that, while you would relieve, perhaps, some 
area of uncertainty, the major part of the field remains untouched. 


It is not that I have any objection to going along with that idea. I 
simply don't think you get very far toward solving the problem. 

Mr. George: How about the other test? About degree of control 
by a small group. 

Mr. Austin: I don't think that you have much application of 
Section 102, or even too much fear of it, in those cases where there is 
wide distribution of shareholdings. 

Mr. George: Isn't that equivalent to supporting the suggestion 
that there should be a limit? 

Mr. Austin: Well, if there isn't much of a problem there, while I 
don't object to that limitation, I don't think it goes very far toward 
solving our main objective. 

Mr. George: I see. 

Mr. Gornick: There are other areas of uncertainty. That is only 
one. But I think that if you try to specify a certain percentage of earn- 
ings or percentage of stockholding, you do eliminate an area of un- 

Mr. Austin: I didn't address myself to the percentage of earnings. 

Mr. Duiker: Take the Trico case. They have 2,500 shareholders 
and yet the control — 

Mr. Austin: Control was in a small group. 

Mr. Duiker: That's right. 

Mr. Gornick: Yes, but under the reasoning of the Trico case the 

amount of shareholding doesn't matter too much. In fact, I believe 

one of the fact-finders in this very panel stated that it may apply in 

„ . , ^ a case where even k per cent of the stock is 

Basis of Control . , ^ AT „ . . .., . 

owned by a group. Well, now, things like that 

cause the uncertainty. So I believe if you make it 10 per cent or 
15 per cent, you do tend to eliminate a large portion of the uncer- 
tainty — again without any adverse effect on the Treasury. 

Mr. Gainsbrugh: Mr. Austin says that the applicability of Section 
102 to a widely held corporation is highly theoretical. In my limited 
experience, it comes back to a personal or qualitative judgment on 
the part of a businessman as to whether he is or is not to be fearful 
of 102. He lacks objective criteria. 

Mr. Austin: Now, just so that it will be clear on what I said, the 
vast majority (majority, I think, is a small word to use) of the cases 
that have actual or potential 102 problems are cases in which you 
have pretty concentrated control and substantial income. It's true that 
you can eliminate many of these cases at the fringes, but the central 


objective of this problem you don't begin to touch unless you deal 
with more radical changes. 

Mr. George: Yes. May I interrupt here? Both the ideas and the 
differences of opinion are taking form, and we do want to get a 
general expression. There is more going to be said voluntarily by the 
participants when their turn comes, and I'm going to suggest that we 
drop it for the moment and allow it to be taken up in whatever way 
it arises. Mr. Connolly, will you proceed. 

Statement by John L. Connolly 
Secretary, Minnesota Mining & Manufacturing Company 

Mr. Connolly: Mr. Chairman, I think I find myself somewhat out 
of step with the subcommittee of the American Bar Association which 
I hate to say, being a member of the Bar. Maybe my disagreement with 
the subcommittee is due to my inability to grasp just exactly what 
their recommendations are. As I see it, they would divide the burden 
of proof, and I don't think that's a good thing. I don't know whether 
it was Mr. Austin or this other gentleman who said that this is a 
question of burden of proof. 

Mr. Austin: It was Mr. Gemmill. 

Mr. Connolly: I do not think dividing the burden of proof solves 
the problem completely. The Magill committee made a recommenda- 
tion that the burden should be shifted to the Commissioner in all cases. 
I happen to be a member of that committee, and iur ^ en f p roo f 
I know I was severely taken to task because some 

lawyers say, "Well, that does not mean anything." I do not agree with 
this, but I acknowledge it does not completely solve the question. Now, 
when you divide it up the way the subcommittee of the American Bar 
Association would do, it makes it worse than the Magill suggestion. 

I would repeal the statute completely, except as to those corpora- 
tions that are classified as investment or holding q| St(Jtute 
companies. Those would be the companies that 

are not now classified as domestic personal holding companies under 
the personal holding company act. 

I have given a great deal of consideration to some of the remedies 
proposed that Mr. Gornick has mentioned; that is to limit the appli- 
cation, or to exclude, rather than limit, certain Liinih|t|on rf ^ 
corporations from the provisions of the act by 

definition, where they are publicly owned and no individual or group 
of individuals owns more than the percentage provided in the domestic 
personal holding company act. I've forgotten the percentage. 


Mr. Gornick: Five shareholders holding not more than 50 per cent. 

Mr. Connolly: That's right. 

Mr. Duiker: Directly or indirectly. 

Mr. Connolly: But I abandoned that idea because it focuses the 
searchlight upon those corporations. Maybe you should; maybe you 
shouldn't. I don't know and I will not sit in judgment upon them, 
so I abandoned that theory. 

I examined all of the cases that have been tried from 1913 down to 

D , • •£. . x 948, and the total amount that has been col- 

Revenue Insignificant , 

lected or in dispute was only $19,000,000. This 

is not worth the effort, for all of the uncertainty and all of the hard- 
ships that it has caused the taxpayer. 

Mr. George: Well, may I ask there, to round out the meaning of 
your statement: How much distribution do you think was effected 
because of the tax that never found its way into litigation channels? 

Mr. Connolly: I had no way of finding that out. I talked with Mr. 

Williamson, who I understood was working on this panel, and he 

said he was going to attempt to get the figures on cases that had been 

a * d j -tl l settled, from the Treasury Department. But 
Amount Paid Through . , 

_ „ , " there is no way of finding out how much really 

found its way into the tax coffers through fear — 

in other words, dividends that were declared and tax paid primarily 

because of fear of the effects of the statute. 

Discussion of Statement by John L. Connolly 
Mr. George: In considering the effects of the act, you'd regard that 
as almost equally important, wouldn't you? The amount of the reve- 
nue would not be a measure of the effect of the tax. 

Mr. Slitor: Indirect revenue must be prop- 
Indirect Revenue Must , . . . , . , ,. _> \ 
„ „ .. J erly considered, along with the direct. That is 
Be Considered y _ . ° „ , 

one 01 the proper purposes 01 the provision. 

Mr. George: Yes, I should think that would be so. 

Mr. Austin: Much the same way that the fraud penalty operates — 
they don't look at the revenue in terms alone of what you've collected. 

Mr. Duiker: And it runs into billions. (Laughter) 

Mr. Austin: It has a compulsive effect. 

Mr. Connolly: Well, when you come to sum it up, I do not think 
that it is much more, probably, than another $19,000,000 over that 
period of time. 

I just have one other point to make. I would sing the song, "If I 


Had My Way," I would repeal it. Not having my way, I would take 

the next best thing such as House Bill 6712, r 1 

passed in 1948, and I would provide in the bill 

the tax should only apply to the amount unreasonably accumulated, 

and provide that in any controversy tried in the Q . 

district court or the Court of Claims, the Com- ., •.•"■'*. 

Unreasonable Portion 
missioner would have the same burden he has 

before the Tax Court. 

Mr. George: Would you repeat that last? 

Mr. Connolly: Well, there is a provision in H. R. 6712 to the 

effect that the Commissioner has the burden of proof before the Tax 

Court. But in refund claims where it might be _ , , _ , 
. , , r . ,. , ~ r Burden or Proof 

tried before the district court or the Court of 

Claims, the statute is silent as to the burden of proof. I would put that 

burden on the Commissioner in the district court and the Court of 


Mr. Duiker: That is in all litigation concerning it? 

Mr. Connolly: All litigation. 

Mr. Duiker: That is a limited burden under H. R. 6712. 

Mr. Connolly: Well, I would make it more than a limited burden. 

Mr. Duiker: H. R. 6712 provides that the burden would be shifted 
if the taxpayer submits evidence to the Commissioner and then he 
litigates the case. 

Mr. Connolly: I would squarely put the burden upon the Com- 

Mr. George: In all cases? 

Mr. Connolly: Yes. 

Mr. George: As distinguished from the proposal — 

Mr. Connolly: That's right. 

Mr. George: Any comments? 

Mr. Richardson: Well, I would like to go on record as heartily 

supporting that general statement, because of the feeling — and a strong 

feeling — that in any matter under tax law, where it is a pure clash 

of judgment, in which there are no statistical data to support a finding 

under the particular statute (the facts cannot support it, it must be 

judgment) the burden must be upon the Commissioner if he is going 

to go contrary to the judgment of the businessman involved. And 

that would apply to 102 and many other matters. 

Mr. Slitor: You would apply that to depre- _ . . 

. . , u ; r Depreciation 



Mr. Richardson: I would apply it to depreciation, to officers' sal- 
aries, to — 

Mr. George: Mr. Sonderman, will you — is something troubling for 
expression in you? 

Mr. Sonderman: During the past month I have taken the occasion 
to discuss Section 102 with various company representatives in Mil- 
waukee for the purpose of determining a proper dividend policy, in 
view of the fearfulness and uncertainty in the 
application of Section 102. I know it is the in- 
tention of practically every company to make a proper distribution of 
its earnings to its stockholders, but regardless of the amount of the 
distribution, they are still uncertain about the outcome. 

Mr. George: You may want to add to that later, but as to the 
particular point that was raised by Mr. Connolly's suggestion — would 
you care to comment on that now or reserve it? 

Mr. Sonderman: I believe it advisable that we reserve the question 
until later on. 

Mr. George: Are there any other comments on this? 
Mr. Gemmill: We had this a few years ago with a deficiency divi- 
dend provision, that if the corporation did get 
e iciency caught, it could distribute and thus get out of 

Dividend Provision , j 

90 per cent or 100 per cent, or whatever. 

Mr. Connolly: Well, I have given considerable thought to that 
remedy, and you get into other problems there. It was Mr. Duiker who 
mentioned the piling-up in one year of dividends that were declared 
out of earnings made over a period of three years, placing the stock- 
holders in the high surtax brackets. That's one of the difficulties 
caused by eliminating it, although it might be better than paying 
the penalty tax. 

An alternative would be to throw the tax back into the taxable 
year of the taxpayer in which the corporate earnings were earned. 
We have precedent for this, and we have provisions in the law for 
other types of income in which that is done. But then you would have 
the claim that there is no penalty upon the failure to distribute. Well, 
at least there would be the 6 per cent interest. I would go along 
with it in the second alternative or the first alternative, if it could be 
worked out. 

Mr. George: Mr. Duiker? 

Mr. Duiker: I'd like to clear you on one point. I'm completely 
unconcerned with burden of proof. I'm sorry it got into this plan of 
mine the way it did. 


There is only one thing that we're trying to do. As the law stands 
at the present time, any tax may be imposed as a penalty, an unfair 
penalty. I want a penalty to be proposed only where it is deserved as 
a penalty. As in all other cases, where the Treas- 
ury tries to invoke a penalty for what amounts 
to fraud, the burden is on him. It is only in that 

respect that you worry about burden. In all other cases, it's the same 
kind of a burden the taxpayer has in any other tax case, and you only 
try to arrive at a fair result by the elimination of a penalty when the 
penalty is not deserved. 

Now, that is how we get into this burden of proof situation. And 
the reason you have the election — you could draw the statute another 
way and simply say that the Commissioner may proceed by way of 
fraud against the corporation that unreasonably accumulates surplus 
for the purpose of avoiding surtax. Let it stand that way, and he auto- 
matically has the burden of proof where he imposes the 50 per cent 
penalty. But because for so many years the penalty has been associated 
with a civil litigation, we had to draw the statute that way, without 
regard to saying whether we're going to divide the burden just be- 
cause we're worried about the burden. I'm not worried about the 
burden. I do think that where you have a question of judgment the 
burden of proof has got to be on the taxpayer in all questions of civil 

Now, where the Commissioner says that you've done something 
wrong, and "I'm going to make you pay a fraud penalty for it," in 
addition to the tax and the interest, that's his burden. 

Mr. Connolly: Well, after after all, this is a penalty tax, so why 
should not the Commissioner have the burden? 

Mr. Duiker: Of course, we don't want it to be a penalty. 

Mr. Connolly: Well, the 50 per cent is a penalty tax. 

And when you put into this statute the provisions that were there 
in '13 and '16, that the failure to distribute was fraudulent, you're 
stepping back into the dark ages. As Mr. Austin n , _ 

• j 1- ^ • • u ui • Pena,t y Tax 

pointed out, the Commissioner probably even in 

the fraud cases would say, "Well, I'll take the other route. I won't 

have the burden." 

Mr. Duiker: Well, I think in some cases the 381/2 per cent is a 
higher penalty than a straight 50 per cent fraud penalty would be 
on the tax of that same taxpayer. 

Mr. Connolly: Fifty per cent of the income would be a higher tax. 
It's 50 per cent of the undistributed income. 


Mr. George: Undistributed Section 102 — 

Mr. Connolly: — rather than 50 per cent of the tax. 

Mr. Duiker: That's right. 

Mr. Gornick: As against 27J/2 P er cent an ^ $i/ 2 P er cent as now - 

Mr. Connolly: Yes. 

Mr. Duiker: But again you see it identifies the offense for the 
historic penalty of 50 per cent. 

Mr. Gemmill: The 50 per cent is 50 per cent of the tax. 

Mr. Duiker: That's right. It has been 50 per cent of the tax. We 
deliberately made it 50 per cent, instead of 27^ per cent and 381,4 
per cent of an unreasonably accumulated surplus, so as to identify it 
by the rate, you see, as a — 

Mr. Vickrey: Why not call it 50 per cent of the 77 per cent maxi- 
mum rate which would be 381,4 per cent? 

Mr. George: Well, let us continue gathering views, for the mo- 
ment, before we try to settle on a consensus about them. Martin Gains- 
brugh, Chief Economist of the National Industrial Conference Board, 
we would like to hear from you. 

Statement by Martin R. Gainsbrugh 
Chief Economist, National Industrial Conference Board 
Mr. Gainsbrugh: I'd like to pick my way through these policy 
questions with two frames of reference: First, on the basis of experi- 
ence in the past and, secondly, as such policies relate to the economy 
currently and in prospect. 

Interest in 102, I believe, as manifest in our membership, as well as 
from meetings with various members of the Board in different sec- 
tions of the country seems to have diminished 

rather than increased. I should say it was at 
Interest in 102 . . , . t*t • 

white heat about a year or two ago. We just 

don't hear quite so much of it from our membership now as we did 

When we did, the biggest question that was raised by the business- 
man, as distinct from the tax practitioner, was: Is this applicable to 
us? The demand throughout was always for clarity. I am in full accord 
with the stress Mr. Gornick placed upon the need for clarity, and 
with some of the policy recommendations made 

djgn under that particular heading. I was interested 
They Were Acting , r _- , & , . 

in the comment that so long as businessmen 

acted in good conscience, they need not be fear- 
ful of Section 102. So far as the variety I met with, they all felt they 


were acting in good conscience. That did not seem to be an issue at all. 

What was disturbing to them at that time seemed to be that the 

good conscience of other people was in question, the good conscience 

of their tax advisers and accountants and others. They had listened 

to one group and then another group of tech- . . 

nicians. They were told in some instances, "Your _ . , 

• » • • -j i t- u j Received 

corporation s securities are widely held, you need 

not be concerned with this problem at all." And they had been to 
another group of advisors and were told that despite the widespread 
distribution of securities, "You are still in jeopardy on this. You had 
better move in the direction of gaining the maximum amount of pro- 

I think over the last year or two they have devised ways and means 
of getting that greater degree of protection. They haven't, I believe, 
gotten a greater degree of clarity. But they have 
spent a great deal of money and time preparing *.■»*•• 

economic and accounting briefs and other spe- 
cial documents which might be manifestations of their strength of con- 
science, in terms of their immediate policies. 

I would say that, to this day, the movement has been toward cloud- 
ing the issues rather than toward clarity. As a result, additional protec- 
tive measures have been devised, in the hope that the corporation 
would be on stronger ground when it is challenged. 

Mr. Slitor: These protective measures are a part of the use of 
funds, as well as sustaining the actions with respect to taxation? 

Mr. Gainsbrugh: Primarily the second — developing a series of 
memoranda which are attested to by authoritative names to the effect 
that these funds are being set aside and are being used for purposes 
which are warranted, in their judgment. Market researchers are 
brought in, as are economists and others who have some knowledge 
of current and foreseeable trends, to support the policies. 

Mr. Slitor: That is a natural concomitant of the historically high 
rate of retention of earnings since the war. 

Mr. Gainsbrugh: Well, we come to that a little later. I think the 
tight equity market situation in which we now find ourselves may 
continue for some period of time, perhaps for a long period of years. 

I turn from that, however, because you have already had your sur- 
vey of facts, to the relationship of 102 and questions of policy under 
102 to the present and the future economy rather than to its impact 
in the past. I think it is desirable that we sharpen up our policy recom- 
mendations in terms of the shape and structure of the present and 


foreseeable economy. There we run up against several developments 
in which policy recommendations seem warranted. 

One of them is the marked shift in the degree of financing internal 
funds currently, as compared with the past. There is no question, at 
least from the figures that are currently available, that a far higher 
degree of corporate financing is now necessary 
Financing Through thrQUgh internal funds than at any pe riod in 
Internal Funds the ^ Secondly, so far as any studies have 

been made, officially and unofficially, for the years immediately ahead, 
capital requirements will continue to bulk large. These projections 
reveal that the primary source of capital for the years of expansion 
that are asked for by the federal government and sought by private 
industry as well, will again be internal earnings, to a very high extent. 
We have had a complete departure from the past. I think the 70 
per cent ratio or some of the other figures that have been cited here 
today need to be restudied. Are they still ap- 
plicable in an economy of marked expansion 
rather than the mature or "stagnant" economy of a decade or two ago 
when some of the provisions of 102 were developed? There is certainly 
a problem area to which some of our policy recommendations ought 
to be directed. 

Along with the problem of sources of funds for expansion is the 
problem of job creation for the future. This, too, is much greater in 
absolute as well as relative size than at any time in the past. And a 
large role is frequently given to the encourage- 
ment of new types of businesses and new types 
of products in that process of job creation. There I think that some 
of the policy recommendations for the elimination or exclusion of 
small business fit into the proper framework. 

Small business is an area which has been, according to the fact- 
finding report, extremely concerned with Section 102. My definition 
of small business would go beyond anything I've heard here today or 
found in the fact-finding report. A definition of small business can 
only have merit on a relative rather than an 
Small Business absolute basis. In our search for equity, I think 

we work tremendous hardship to some sections of industry through 
the designation of small business by an absolute level. Many of the 
businessmen or the executives of business corporations and enterprises 
that I have met with in the past, if I apply popular standards, are not 
small, but medium-size, using an absolute size classification. And yet 
they are the ones who've been hit hardest in many instances by Sec- 


tion 102. I do not mean the small retailer, or the small wholesaler. The 
small firms I have in mind are machine-tool operators, foundries, 
electrical appliance manufacturers, etc. They are definitely in the 
lowest decile of their industry on the basis of assets, sales, and employ- 
ment. By all relative standards they are small; by any absolute stand- 
ards, such as those that have been suggested, they are denied relief by 
some of the policy provisions which have been advocated. 

Mr. George: May I interject here — this is a very pertinent point. 
It has often occurred to me. When the suggestion was first made, it 
occurred to me: What good does $25,000 do to a steel company? And 
yet I have no answer to that, because I would expect that it would be 
a very difficult job to draw up a scale of minimums for different types 
of industry. I wonder if, as the discussion went around the table, 
someone would come in and grapple with that. 

Mr. Austin: That was part of the point of my earlier remarks. 

Mr. Gainsbrugh: I think even the absolute levels that have been 
cited so far are completely out of keeping with the present price struc- 
ture, and with the change in the dollar amount of profits or sales of 
industry postwar as compared to prewar. 

Mr. Vickrey: Well, might I interpose that it seems to me that the 
size of the industry is irrelevant here, in that the issue is one of access 
to the market for funds — which I would take to be more a matter of 
absolute size than relative size in the industry — and a matter of the 
income tax status of the dominant shareholders, which again is a 
matter of the absolute size, together with the degree to which earnings 
are distributed. 

Unidentified Speaker: I thought one of the points advanced earlier 
was that small business should be given the greatest degree of encour- 
agement, but not to be restricted to one or two — (colloquy) 

Mr. Slitor: Isn't it well established, as pointed out in the Treas- 
ury study of the taxation of small business, that retained earnings are 
held to be properly accumulated if retained for working capital needed 
by the business, if invested in additions to plant, reasonably required 
by the business, or put into a sinking fund for retirement of bonds 
in accordance with a contractual obligation of the corporation? Now, 
are these additional capital requirements to which you refer require- 
ments for additional bank deposits or government bonds? 

Mr. Gainsbrugh: No. 

Mr. Slitor: Do you believe that a small business should be con- 
cerned about the application of Section 102 if it diverts its retained 
earnings into the expansion of its plant, into normal growth? 


Mr. George: I think those are all very good questions. I think 
parts of them have been answered by the fact-finding panel. 

Martin, I apologize for interrupting your statement. This point is 
likely to be very important and I was sure you would be willing to 
round it out, and I did feel that it would not stand until it was 
rounded out. Will you complete your statement? 

Mr. Gainsbrugh: Much of what I have said is admittedly chal- 
lengeable and was tossed out with that purpose in mind. But I've 
read carefully the preceding material and it did not seem to me that 
some of the present and foreseeable problems have been brought into 
the discussion. I do think they affect policy recommendations. 

I would like to offer one case study in response to the question 
that was raised. The provisions of Section 102 are clear; why need 
industry be fearful? 

Mr. George: I think that's in order. 

Mr. Gainsbrugh: This company had embarked on a long-range 
program of expansion. It, like many other corporations, is currently 
engaged in testing out its market. It has expanded up to X point; 
there is the possibility of expanding beyond that to Y point. The 
directors wished to postpone investment for a period of months in the 
hope of testing out their market. It might be too risky for them to 
engage in further expansion of capacity at the current time, although 
they are looking forward to it. Meanwhile, they would like to retain 
those funds, to have them at their command, in the event that their 
tentative opinion of the market is confirmed. But they are pressed 
toward distribution of funds within the given year by fear of "undue 
accumulation." Their middle-term, to say nothing of their long-range 
program, is obstructed by Section 102. 

Discussion of Statement by Martin R. Gainsbrugh 
Mr. Slitor: Of course, among the facts considered in applying 102 
is the past record of dividend distribution of this company, and also 
the current and prospective needs of funds for expansion. I should 
think that the corporation in that situation could very well stand on 
its record and the facts in regard to its future plans. 

Mr. Gainsbrugh: Well, perhaps that underlies one of our recom- 
mendations for an educational program. If the statements that you 
have made are as clear-cut as they seem to be at the moment, then 
it may have a very significant effect upon businessmen's thinking about 
102 and, I suppose, the sources of advice on which they rely for pro- 
tection against 102. 


Mr. Richardson: May I add a comment in line with that? I will 
go along with the query: Why shouldn't the company be satisfied? But 
we know in practice that it hasn't been. The exact situation which is 
given as an example is one instance, where increased dividends in the 
current years took place, but they had a long- variations in 

range plan involved. The agent examined and Admin j strative 

in his report, which he had to include, he gave Attitudes 

the statistical data which showed the distribu- 
tion, and showed that the distributions were higher than they had 
been in previous years. He sent his report in with a specific recom- 
mendation that 102 should not be applied, that he had examined the 
situation. And it was kicked back from Washington on review with 
the statement that 102 should be applied. 

Now, I'm not finding fault with the administration now (although 
I can under those circumstances). But how do you eliminate the un- 
certainty in the businessman's mind when that does happen? He does 
have this history; he does have a history of distribution which shows 
a slightly increased amount, and increased percentage, and he thinks 
it's perfectly sound and he depends upon it. And he goes through an 
examination and he's happy. And he still gets it back in his lap. 

Now, I feel that policy, if we can determine one, should be a policy 
that eliminates uncertainty, if it can be done. 

Mr. George: How frequently do you think that type of case oc- 
curs, where there is an apparent understanding between the field agent 
and the taxpayer, and the case bounces back? 

Mr. Richardson: Well, it's rather difficult for me to answer that 
because my understanding, from discussion with revenue agents, is 
that it happens more often than my own experience would indicate. 

Mr. Sonderman: It has recently come to my attention that con- 
siderably more cases have been returned from 
the review section of the internal revenue agent's Section 

office for re-examination of Section 102, espe- 
cially in cases where small deficiencies are determined. 

Mr. Richardson: I think there is definitely a field of uncertainty 
that results from the return of a case which has been reviewed by 
somebody who knows nothing about it, who is solely looking at sta- 
tistical data which cannot of itself control. Statistical data cannot be 
the measure of 102 application. And yet such cases certainly exist be- 
cause any number of businessmen know that cases come back for a 
fight when accumulation shows up in the statistical data. 

Mr. George: I'm interested in one implication of what you're say- 


ing, Mr. Richardson. Your remark really challenges the function of a 
review itself. I was interested to note that one of the proposals that 
came down to us in previous deliberations was that there should be 
established in Washington a central section or board or committee of 
review which would examine all cases before 102 was applied. 

Mr. Duiker: We virtually have that now. 

Mr. Richardson: Well, as a practical matter, you're having that 
because the agent must submit, under most circumstances, the data 
under 102; so that you're getting a post-review of that data, and a com- 
mittee reviewing all circumstances would be reviewing that same 

Mr. George: And there must be such a review. You would con- 
cede that, would you? Administratively. 

Mr. Richardson: If we're going to have the agent make the origi- 
nal determination of whether 102 should apply, then there must be 
that review by somebody with more experience and better judgment. 

Mr. George: Well, the question is raised here: How do we im- 
prove the quality of the review? Rather than challenge review itself. 

Mr. Richardson: You're going to get into something that's going 
to take you away from this subject. It's a wide-open field. (Laughter) 

Mr. George: Not unless I follow it. (Laughter) All I was trying to 
do was to crystallize the kind of questions with which we're con- 

Mr. Richardson: I do think that that is one of the problems. The 
feasibility of a committee in Washington reviewing this is something 
that, from a policy point, we need to pass upon. Administratively, I 
think policies from the taxpayers' point of view are going to be con- 
trary to policies from the Bureau's point of view. 

Mr. George: Very unfairly, Martin, we've cut your time into 
shreds. Would you like to complete it? 

Mr. Gainsbrugh: Let me come back, by way of summarization, to 
my final point. I would re-emphasize the argument earlier that we lack 
clarity and that lack of clarity becomes an obstacle to business de- 
cision and is rather costly in terms of time, effort, and mental anguish. 

Secondly, I have called attention to dividend policy of the present 
and of the foreseeable future as distinct from the dividend policy of 
the past. It is my belief that the policy of the past cannot be used as a 
criterion for the policy of the present and the future because of equity 
capital shortage, etc. I have also directed some degree of attention to 
the necessity for a relative definition of small business, rather than for 
an absolute definition. 


My final comment is on stability and the relation of Section 102 to 

Mr. George: You mean economic? 

Mr. Gainsbrugh: I mean economic stability. We appear to have 
accepted as our national goal the minimization of the amplitude of 
business cycles, if not their obliteration. I think Accenhjation f 
there is evidence from the fact-finding panel that Economic Cyc | es 
Section 102 provisions have accentuated cyclical 

amplitudes rather than led toward stability. They have, in a sense, 
prejudiced investment policy in the direction of inflationary pressures, 
rather than in the direction that is viewed as desirable. 

I am particularly impressed, in that connection, with one of the 
recommendations calling for a period of years, rather than for a given 
year. Mr. Gornick cited the desirability of a four- or five-year period. 
He advanced various reasons for that. My pri- m Cons|deration on 
mary emphasis would be that a four- or five-year FourFJve YeQr Period 
period is sufficient to cover the duration, at 

least, of the normal business cycle. It would, therefore, give a frame- 
work of a full period of business activity from trough to peak and 
back to trough again, as the basis against which retention of dividend 
policy is to be judged. 

I would say, finally, that one very good purpose, indirectly, has been 
served by Section 102. It has made an increasing number of businesses 
aware of the necessity for developing at least a middle-term program, 
if not a long-range program. They have been forced to look beyond 
the immediate year to a more extended period of time in business 
planning, and that is most desirable. 
Mr. George: Any further comment? 

Mr. Gornick: I'd like to make one. It seems to me there are really 
two problems. There are two situations where 102 comes into play. 

The Treasury has nothing whatever to do with the first situation. 
That is the situation where, toward the end of the year, management 
has to sit down to determine what dividends are going to be declared. 
They consult with their tax advisers and their accountants, and they 
face the question of, "What should we do?" Now, at that point the 
tax practitioner has to advise his client as to what the law requires, 
and he takes a look at 102. And he takes a look Uncertainty and 
at the situation in front of him. Let's assume Dilemma 

that here is a little corporation — a corporation 

controlled by a small family group; 80 per cent, let's say, is owned by 
one group of individuals. Let's again assume they're in the manufac- 


turing industry. One small corporation in an industry — there may be 
other corporations with profits of a hundred million. This year is a 
boom year in most business. I think profits will be higher than they 
have perhaps been since 1929. I think all business generally is taking 
a conservative view of the amount of dividends to be paid. As a mat- 
ter of fact, I can cite figures on that. The Bureau of National Affairs 
says: "Dividends are expected to set an all-time record of $9.5 billion 
in 1950. This distribution of 49.5 per cent of estimated profits after 
taxes is higher than in previous postwar years but it is far below the 
ratios of prewar boom years of 69.2 per cent in 1929 and 62.8 per cent 
in 1940." 1 Prospective requirements for corporate funds suggest that 
dividends should not exceed 49.5 per cent which is less than in the 
prewar years. That's business generally, all business in the United 
States — not the little controlled business, but generally business takes 
the view of 49.5 per cent. 

Well, let's come back to our little man in his corporation. He comes 
to you as his tax man, and he says, "Now, look, I'd like to keep 50 
per cent of these profits because this is a period of good earnings; what 
the future may be, I don't know. One thing I do know: That costs are 
tremendously high, that the chances are within the next three or four 
years, there's going to be a downward cost spiral. Until that happens 
I'd just like to salt this 50 per cent away in my place here and put it 
in government bonds or something else. Is that all right?" 

What does the tax adviser do? He says, "Well, now, wait a minute. 
You're going to keep 50 per cent of your profits. You've already had 
earnings here that are rather substantial. You're closely held." He 
takes a look at the Treasury Regulations and all he sees in there bear- 
ing upon his problem is something about the reasonable needs of the 
business, and a small addition to a sinking fund to retire indebted- 
ness, and that's about all. He looks at the cases and he finds out that 
the courts generally do not look with favor on retained earnings for 
distantly future contingencies. He replies, "You can't salt this away 
for something that may happen in four or five years, or a year from 
now. Under the decided cases, to be safe you ought to go out and 
commit these funds." 

The businessman says, "You're crazy. This is probably the worst 
time in the world to go out and invest in plant and equipment and 
what not." 

Now, there is the field of uncertainty and dilemma. How can a tax 

1 Bureau of National Affairs, Inc., Daily Report for Executives, Special Report 
No, 11, Washington, May 24, 1950, p. 3. 


adviser help guide this man in any reasonable way? I defy anybody to 
be able to tell that man with any degree of certainty that he's per- 
fectly all right in keeping 50 per cent — although the statistics I just 
cited to you will indicate that business generally throughout the 
United States is retaining 50 per cent. And yet, I dare say that today 
there's uncertainty involved in the case of any closely held corpora- 
tion, if it were to retain any appreciable amount of earnings. 

Mr. Slitor: The statistics quoted in Professor Williamson's report 
indicated, of course, that small business retained a much higher pro- 
portion of its earnings than large business. And if you look at the 
smaller size classes included in his table, you will find that small 
business has been retaining 80 per cent and more of its earnings, on 
the average. 

Mr. George: Gentlemen, I think that the question raised by Mr. 
Gornick is simple, thorny, and pertinent. 

Mr. Austin: In other words, you think it is too complicated? 

Mr. George: No, not at all. 

My thought at the moment is to leave that excellent example and 
the reply hanging there until we get back to recapitulation of all the 
ideas and the support there is for them. 

I think at the moment, if it is agreeable to you, I will ask Mr. Slitor 

to say something. I might say this, although I think he is well aware 

of it: That all the panels that I have had anything to do with have 

had a deeply sympathetic appreciation of the , 

terrific problems that the Commissioner has in . . . . ^ . 

■ ... . . . - , Administration 

administering this provision, and at the last 

meeting I was rather surprised at the near unanimity with which the 

members felt that the Commissioner was doing about as fair a job 

as anyone could do. The problem lies in the elements of the difficulty 

at which the tax is aimed, and the difficulty of arriving at a proper 

set of provisions for dealing with it. 

But that aside (which I am sure you understood anyway), we'd like 

to know how you feel about the various things that have been said 

here, and what ideas you may have yourself to contribute to the 


Statement by Richard E. Slitor 
Assistant Director, Tax Advisory Staff of the Secretary of the Treasury 

Mr. Slitor: I don't know that I can express any view particularly, 
but I might say this: We have heard quite a barrage of criticism here 


of Section 102, and various policy suggestions, most of which are 

directed toward liberalizing the application of 
Section Might Be . , ° .u 

Section 102. As you probably are aware, there is 
More Stringent . , , r . . , c . 

at least some body 01 opinion that Section 102 

should be revised in the other direction, that it doesn't at present have 
teeth, that it is not producing the distribution that it should in the 
interests of equity and desirable economic effect. Now, I trust there 
may yet be some members of this panel who will suggest that the 
possibility of revision is not entirely one-sided, and that there is pos- 
sible room for making it more stringent in some respects. 

Mr. George: Speaking impersonally, and merely out of the kind 
of evidence and opinion that has come to you down there, would you 
care to be more specific? 

Mr. Slitor: I'm sure you are aware of this other type of criticism. 

Discussion of Statement by Richard E. Slitor 
Mr. George: It is just that I wanted to have it before the group 
for discussion. 

Mr. Slitor: Well, I am not necessarily expressing my own view. 
I am simply passing on to you this other school of thought that one 
hears of from time to time. Of course, they can cite the fact that the 
rate of retention of earnings is extremely high and, in cases where 
there is criticism of Section 102 as forcing dividend distribution, the 
facts often are that those corporations are retaining 80 per cent or 
more of their net income after tax. 

Mr. Richardson: I wonder if I might ask, purely for informative 
purposes: Where does this school hold its sessions and who is attend- 
ing it? Is it an economic school? 

Mr. Duiker: It is probably an economic policy. 
Mr. Richardson: In other words, it is related solely to a school of 
thought that large distributions were necessary in order to allow indi- 
viduals continuously to make up their minds whether they wanted to 
reinvest, rather than to allow corporate management to determine 
whether they would reinvest. 

Mr. Slitor: It is also believed by some that the relative scarcity 

of equity capital is in part induced by the com- 

opi a carci y an p arat i V ely small flow of dividends, and that the 

Dividend Flow . c .. * A 

apparent stringency of venture capital and 

equity capital would automatically be removed if dividends assumed 
the same relation to earnings that they did before the war. 

Mr. Richardson: Well, now, the reason for my question is this: 


What if that school of thought finds fault with Section 102 — if it 
finds fault with a high individual tax rate? Because that is the only 
reason that 102 — 

Mr. Slitor: Critics of Section 102 of the type I mentioned fall into 
two specific classes. They are either concerned with Section 102 within 
the framework of the present law, or more basically, they're concerned 
with the present type of basic framework, in ^ 

which there is a lower tax on undistributed earn- 
ings which are taxed only once, whereas distributed earnings are taxed 
twice. Some observers don't like that type of unneutrality. But, given 
that unneutrality, they think that Section 102 might be made more 
stringent to help correct it. 

Mr. Gornick: Well, actually, it isn't 102, is it? It's really directed 
against undistributed profits of all corporations; 102 is aimed primarily 
at the small, closely held — I'll say "closely held" and leave out the 
word "small" — and, I think, over-all that is not too large a segment 
of all the corporate business done in America. Most corporations, I 
believe, would fall in the publicly held category where not more than 
10 per cent or so of the stock is held by any individual. The aggregate 
retained earnings of all closely held corporations would be small when 
compared to the combined total of earnings re- 
tained by publicly held corporations such as 
United States Steel. Therefore, it is doubtful that 

equity capital would be greatly increased by tightening Section 102 to 
force distributions by this comparatively small group of closely held 
corporations. I think what you refer to is the fact that all corporations 
are only distributing 49 per cent of earnings, over-all, rather than 60 
per cent or 70 per cent. In other words, my guess is that what you refer 
to as the thinking of this school is directed at something in the nature 
of an undistributed profits tax applicable to all corporations, whether 
closely held or otherwise. 

Mr. Slitor: Various people suggest various remedies. 

Mr. Austin: It isn't so much a matter of remedies as it is of objec- 
tives. Section 102 assumes the validity of retention of earnings, that it 
may be legitimate. Now, if you assume that as a desirable objective, 

then the section ought to be so written as to . . , _. . . 

& £ . , ^ T . r ,. Matter of Objectives 

carry that objective out lairly. Now, 11 you dis- 
agree with the objective, that corporations should not be given that 
right as against individuals who derive their incomes through personal 
services and so on, then you approach it entirely differently. 
Mr. Slitor: Yes. 


Mr. Austin: It is a matter of basic premise. 

Mr. Slitor: That is right. There are, of course, people who are 

opposed to this basic unneutrality, but accept it 

as a practical fact, although they don't like it, 
Effective 102 , \ . , \ . J r 

and given these facts, they would prefer a more 

effective Section 102 which would still not be in the nature of an 

undistributed profits tax. 

Mr. Austin: As I say, that involves incomplete acceptance of the 
basic premise. 

Mr. Gornick: It is difficult for me to see just what there is to 
criticize about Section 102, from the standpoint of not forcing enough 

Mr. Slitor: These are not necessarily my views, you understand. 

Mr. Gornick: Let us develop them. Here is a corporation in the 

steel business. It has 1,000 stockholders, none of whom owns more 

than 1 per cent of the stock. There is another little steel company — 

let us say they are both capitalized at $ 100,000 — there is another little 

. steel company capitalized at $100,000, and it is 

owned by an individual. Both of them retain 
Ineffective? r . , . r , 

50 per cent of earnings, both for plant expan- 
sion. As Section 102 is now interpreted, it may be applicable to one 
of them but not to the other one. You can go even further and say 
that both of them retain all earnings. Now, how can you criticize the 
closely held corporation against the publicly owned corporation on 
the ground that it did not distribute earnings? It is simply the differ- 
ence in the ownership which is too unfair. 

Mr. Slitor: General Motors may pay a dividend of $100 to two 
different people and they will be taxed at different rates, depending 
upon the other income of those shareholders. Now, I suppose, you 
have brought up a situation where there is a tax avoidance in the one 
case and there is no tax avoidance in the other. 

Mr. Gornick: Well, where is the tax avoidance? We have corpora- 
tion A publicly owned, which finds it expedient from a business stand- 
point to retain its earnings. 

Mr. Slitor: Would you assume any difference in the income of 
these shareholders? 

Mr. Gornick: No, what I am worried about is the corporation. If 
corporation A, a publicly owned corporation, having concededly no 
thought of avoiding surtax on its thousand stockholders, deems it 
necessary because of factors in the steel business to retain 100 per cent 
of the earnings, then why should you say that corporation B, in the 


same steel business, with the same capitalization, by retaining business 
profits is avoiding taxes, only because they have five shareholders and 
if the profits were distributed they would be subject to surtax? I only 
offer the illustration to show that there can't be any criticism of Sec- 
tion 102 now from the standpoint of not forcing enough distribution, 
because actually on an over-all basis the Section 102 corporations have 
to compete with non-Section 102 corporations. But they are now at a 
disadvantage because they not only have to compete in the market 
place, but they have to compete from a tax standpoint. The Commis- 
sioner is holding a club over them, whereas he doesn't over the other 

Mr. Slitor: Well, is there an equal economic need? 
Mr. Gornick: That is my assumption — they are both in the steel 
industry, they are both capitalized in the same amount, they are both 
faced with the same needs. The only difference — 

Mr. Slitor: If the funds are needed for plant requirements, where 
is the Section 102 problem? 

Mr. Gornick: Well, I am simply asking, from your standpoint, 
where is the need for greater 102 tightening up, as applied to corpora- 
tions generally? In other words, your problem really is not an eco- 
nomic problem along that line, but must be concerned with greater 
distribution by all corporations, rather than the ^^ T|ghtening 
use of Section 102 to force distributions from a Stable 

small group. Which goes farther than what you 
stated, which was that the group feel that Section 102 ought to be 
tightened to cause more distributions. I think that that would merely 
accentuate the present inequity, because if such tightening were done, 
you would be forcing the steel company with two shareholders to pay 
out its earnings, whereas the other would not need to pay. 

Mr. Connolly: As I understand it, the school of thought that you 
speak of would strengthen 102, because corporations are retaining 
earnings, let us say, to the extent of 80 per cent (I think that is the 
figure used); and they criticize 102 because the Treasury is unable to 
show that those particular taxpayers have violated 102. They have 
not too much cash, because what they are doing is plowing their 
earnings back into the business, and they have not violated 102. But 
this school of thought would say that Section 102 should be such that 
it would compel corporations to distribute earnings. Am I correct? 

Mr. Slitor: That is a possible interpretation. I am sure there is a 
wide range, and various shades of opinion in this group. 

Mr. Connolly: Does this group take into consideration the fact 


that today about the only place where corpora- 
Retained Earnings i • r * r • * ■, 
tions can obtain funds lor investment is through 
Essential for . . , . _ ° 

retention ol earnings, rather than in the mar- 
Investment , 


Mr. Slitor: Yes, although they point out that the availability of 
funds in the market would be increased if dividends were greater. 

Mr. Connolly: I didn't get that. 

Mr. Slitor: Since the value of common stocks would be enhanced 
if dividend payments were increased, this group points out that the 
availability of equity capital, the marketability of common stocks, 
would be increased with a more liberal rate of dividend distribution. 

Mr. Connolly: Well, that is why I raised my original question as 
to the school of thought, because while I've heard very profound dis- 
cussions advocating an undistributed profits tax for economic reasons, 
I have not seen that school of thought specifically applied to 102, be- 

,„ ., „ . . cause 102 serves an entirely different purpose. So 
102 Not Designed as ; r r 

„ ,. that I think the school of thought can't apply to 

Undistributed Profits . . . . , & , , ,. 

something which we are not, presumably, dis- 
cussing at present, that doesn't apply here. I 
did think that we were getting into an economic discussion rather than 
a tax discussion, per se. We are into the question now of market for 
capital funds and whether it is unduly limited by retention of divi- 
dends, which will lead immediately to the question of the surtax level, 
and by and by we will begin to discuss thoughts on the economics of 
taxation generally, and I am afraid we wouldn't come out with any 
Mr. Slitor: Well, I don't think the record would be complete un- 
less you recognize that the criticism of Section 
Criticism of 102 / ? . .,■.,, , 

_ , . 102 is not entirely one-sided; that there are those 

Not One-sided . , ,. .1111 • 1 -, n 

who believe it should be tightened, as well as 

those who believe that it should be liberalized in favor of the taxpayer. 

Mr. George: Well, you have made that clear. There is a question 
as to whether that school has primarily economic considerations, or 
revenue considerations, or equity, in view. 

Mr. Slitor: They may have in mind all three considerations. Cer- 
tainly the equity consideration is an important factor, and the eco- 
nomic is also. 

Mr. George: Have we before us any particular type of provision 
that this school would make — type of amendment to the present law 
which ought to be considered? 

Mr. Slitor: I can't cite a specific proposal. I think some advocate 


statutory change while others think the administration of the present 
statute should be tightened. 

Mr. George: You say the administration should be tightened — 
would that also mean that the application of it would be broadened? 

Mr. Slitor: Yes, I suppose that they have in mind the application 
of Section 102 in more cases. (Colloquy) 

Mr. Gainsbrugh: I have two questions that I'd like to raise that 
might be helpful, perhaps, in terms of policy recommendations. 

The first one (and they are somewhat related) is: How much mani- 
festation is there within the Treasury itself of uneasiness or discontent 

with Section 102? And the second is: How far is .... _ 

. What Is Treasury 

the Treasury inclined to go along with the rec- AttVd ? 

ommendations for clarification? Is a program 

currently envisioned in which further attempts will be made at clari- 

Mr. Slitor: Well, I am afraid I can't answer that, other than to 
cite the public statements. A number of statements have been made 
by the Treasury, of course, clarifying the administration of Section 102. 

Mr. George: Mr. Sonderman? 

Statement by L. H. Sonderman 
Tax Manager, Harnischfeger Corporation 
Mr. Sonderman: Mr. Chairman, I have a statement of policy that 
I would like to submit if it is in order at this time. I am in agreement 
with a good many of the statements made by Mr. Gornick relative to 
the problems confronting the average businessman in small and closely 
held corporations. So I will go ahead, at your suggestion, and give you 
these grounds: 

I believe that the three modifications in the language of the section, 
which were contained in H. R. 6712 as it passed the House of Repre- 
sentatives in 1948, were desirable, in that they 

H. R. 6712 
would correct certain inequities and, to some ...... . _ . . , 

_ x . . , ., Modifications Desirable 

extent, relieve business, and particularly small 

business, from the worry as to the possible application of the Section. 

The three changes contained in Section 125 of H. R. 6712 were: 

1. To provide for the shifting, in certain cases, to the Commissioner of Internal 
Revenue of the burden of proving that earnings and profits had been accumu- 
lated beyond the reasonable needs of the business. I think 
this change would have been approved if the Commis- 
sioner had been required, instead of merely permitted, Shifting Burden 
to give the taxpayer notice of an opportunity to file a f Proof 
statement on the grounds on which it relies and to estab- 
lish the reasonableness of the accumulation. 


2. To exclude net long-term capital gains from the 
Exclude Long-Term base of tne computation of the Section 102 surtax, thus 
. insuring that such gains would not be taxed more than 

Capital Gains 2 ^ p er cent ^his is obviously a fair provision and one 

that should be adopted. 
3. To permit the taxpayer at its discretion under certain circumstances to take 
credit for dividends paid during the first seventy-five days of the succeeding tax- 
able year. In view of the well-known Trico litigation, however, in which suits 
were filed by stockholders against directors that subsequently were settled by the 
directors paying substantial amounts to the corporation, another type of problem 
under Section 102 exists. While there would be a few 
Timing Leeway cases where directors have attempted to evade Section 102, 

as a result of which liability on their part to stockholders 
may be justifiable, in the great majority of cases the directors have had the diffi- 
cult task of attempting to draw a proper line between reasonable needs of the 
corporation and the duty of the corporation under Section 102 to avoid unneces- 
sary surplus accumulation. The major problem of corporate management today is 
to secure the services of competent individuals and directors. This problem is 
aggravated by the increasing scope of directors' liability, even in cases where the 
directors have acted bona fide and have used their best judgment. 

The situation would be alleviated substantially by the addition to 

the proposed amendments of a provision to the effect that if liability is 

finally determined against a corporation under Section 102, the penalty 

may be avoided by the declaration at that time of a special deficiency 

^ , dividend as above recommended. For the pur- 

Deficiency Dividend . , , , , * 

poses of the year for which the penalty has been 

sustained, credit might be given for all of the 
deficiency dividend subsequently paid or, if deemed preferable, for 
only a fixed statutory percentage of the deficiency dividend. The latter 
would tend to eliminate the run-for-luck idea which some taxpayers 
might read into a provision permitting deficiency dividends. 

It is not believed that many taxpayers would make the run-for-luck 
and knowingly incur large risk of liability under Section 102 in reli- 
ance upon a deficiency dividend provision for at least two reasons: The 
first is that to incur the penalty under Section 102 for any year is to 
invite similar penalty for subsequent years in which new needs have 
been developed and in which less than 100 per cent of the earnings 
have been distributed. The only way to avoid the penalty for an in- 
definite series of future years is to distribute all 
"l^ " * w of the earnings. For shareholders in high surtax 

brackets, this means reducing the dollar of cor- 
porate operating profits to something like fifteen cents which, of 
course, is a most unattractive prospect. On the other hand, it is true 
in all but a very few cases that by distributing most of the earnings in 
each year penalties under Section 102 can be avoided even by pros- 


perous corporations. The full rigors of double taxation are not in- 
curred. Credit for only a statutory percentage in deficiency dividend, 
coupled with the foregoing considerations, would, it is believed, pre- 
vent abuse of the deficiency dividend provision. 

A word may also be said about the reasonable needs of the business 
and use of Section 102 (c) of the Code. Two broad lines of interpret 
tation are possible. One is to confine the need strictly to the kind or 
type of business previously carried on by the ReQSOnab|e Needs 
corporation. The Bureau seems inclined to Business 

adopt this view. The second, and preferable in- 
terpretation, is to permit the accumulated funds to be used in the 
carrying on of any new bona fide business. The latter expression, of 
course, should be denned so as to exclude incorporated pocketbooks 
and other objectionable types of new business, and in this respect, can 
be gotten from concepts and distinctions in the personal holding com- 
panies' subchapter of the Code. 

There appear to be compelling reasons in the public interest for 
permitting bona fide businesses under Section 102 (c). Successful busi- 
nesses often embark upon new projects not necessarily related to the 
previous business. In some instances, the new products fill up seasonal 
slackness, utilize existing machinery, fit into existing marketing facili- 
ties, use existing technical skills or other resources of corporations. 
Sometimes the new business is intended to replace in whole or in 
part an existing business which is growing out-of-date or becoming 
obsolete. Many businesses maintain research laboratories and it is im- 
possible to forecast what kind of a product may emerge from research. 
It has been stated that one corporation, while searching for some- 
thing in the field of dyes, discovered a chemical which proved to be 
a cure for a disease affecting growing wheat. That tends to avoid 
extreme economic cycles in certain industries, and has led to marked 
diversification of effort and products, often wholly new fields. 

It is further reported that a corporation in the food business, as a 
result of skills gained in wartime, branched out into the manufacture 
of metal products. It would be most unfortunate to construe Section 
102 as freezing corporations into the type of business previously car- 
ried on by them. From a practical standpoint, . 

it is no answer to say that the corporation should . . . _ , 

, Major Source or 

distribute its earnings and let the stockholders , t _ . 

. , , , r r Investment Funds 

start the new business with the amount left atter 

surtaxes, which at current rates would be wholly inadequate. As indi- 
cated in a recent report by Emil Schram, President of the New York 


'Stock Exchange, the major sources of equity capital today are earnings 
of corporations. Surtax rates prevent individual accumulation in 
amounts adequate to finance new business. In most instances, if corpo- 
rate earnings may not be used for financing new businesses, the result 
will be that the new business will not be started. Section 102 should 
not bring about that result. And it is possible that the policy of Con- 
gress in this regard should be the subject of legislation. 

I think one of the most serious difficulties in the administration of 
this section is the Department's failure to indoctrinate its agents with 
the thought that the section is in effect a penal section and that it is 
sparingly applied and only applied when there has been an improper 

accumulation. The word "improper" used in 
Should Be Treated as . „ , , , , , ^ . . , - 

the Code should require a determination by the 

agent, first of all, that a taxpayer has done some- 
thing wrong. My experience has been that the agents think a surplus 
accumulation is subject to 102 application merely because it has passed 
a certain percentage figure. Section 102 ought not to be considered as 
an excess profits tax or as any other special kind of revenue-raising 
measure. It is a technical penalty section and should be so treated. 

I think further that inquiry should be limited to those cases where 
there are less than four families of stockholders who control the dis- 
tribution of dividends, unless the evidence is such as to demonstrate 
clearly an existing improper motive behind the failure to pay divi- 
dends. The Treasury Department's administra- 

Should Be Limited to r , , , * u * 

tion of the law at present seems to be based 

osey on ro e U p 0n mechanical determinations and not on 
ompames factual determinations. To correct this, it might 

be advisable for the Bureau to have a surplus specialist who is a 
trained economist and who would be in a position to analyze the facts 
of a given taxpayer in relation to the industry of which the taxpayer 
is a part. This would tend to keep the cases in their proper perspective, 
and would tend to avoid the evil of using Section 102 solely for pur- 
poses of threatening or forcing settlement of otherwise debatable 

Discussion of Statement by L. H. Sonderman 
Mr. George: You covered a lot of ground there, Mr. Sonderman. 
Mr. Sonderman: These are some of the problems that I have been 

thinking about and I am glad to submit them for the record. 
Mr. George: Well, we want your ideas out in the open, together 

with the others. 


Mr. Austin: Do you have any specific recommendation on the 

immediate problem? I'm afraid I didn't quite get that. 

Mr. Sonderman: As to the immediate problem, I would suggest 

that Section 102 be clarified as to its intent and ... 


purposes from a practical business point of view. 

I believe corporations are relying too heavily on capital expenditures 

to relieve them entirely from Section 102. 

Mr. Austin: Yes. It is a little bit disturbing in that regard. 

Mr. George: We have a vast amount of evidence on that point in 
the fact-finding panel and in the questionnaire. 

Mr. Austin: The point of my question was whether you have a 
recommendation to effect that point. 

Mr. Sonderman: I would recommend that in cases where addi- 
tional taxes are levied on the undistributed por- 

r Depreciation 

tion of earnings, that companies receive credit 

for money spent for capital additions, and perhaps depreciation on 
replacement values. 

Mr. Connolly: Well, that goes with the measure of the unreason- 
able accumulations. 

Mr. Sonderman: That's right. 

Mr. Connolly: Mr. Chairman, I think Mr. Sonderman has brought 

out a very good point, and that is the provision to the effect that a 

corporation shall not embark upon a new type . , _ , _ . 

r r y f~ New Type of Business 

of business. Now, the courts have never really 

passed on this question, but in the case of the Lane Drug Company 

they used certain language which would lend some support to the 

Commissioner's idea. 

Mr. George: There is a question in our check list that will permit 
us to focus on that later on. 

May I ask this question: Do you practitioners find that the Com- 
missioner will take into consideration the neces- _ , t _ . 

Replacement Costs 
sity of accumulating funds to compensate for the 

higher cost of replacement even though it is not allowed for tax pur- 

Mr. Duiker: I think so. 

Mr. Connolly: O.K., that's all I wanted to know. 

Mr. Duiker: I ran across this interesting situation in Philadelphia. 

How widespread it is, I don't know. The rev- . 

r Variations Among 

enue agent devised a formula for determining . 

how much capital a corporation needs to take 

care of its current liabilities and its inventory, and he adds up a cer- 


tain number of figures and if the liquidity — amount of liquidity of 
funds is in excess of the amount reasonably required to take care of 
thirty-day credit, limitations and inventory, accounts receivable, then 
he imposes Section 102. Regardless of motive. 

Mr. Austin: Well, that is subjective, isn't it? It varies with every 
agent? That's what I meant by the — 

Mr. Connolly: Yes, I understand it. 

Mr. Austin: I don't think there is a stated Bureau policy on that. 
If there is, it hasn't filtered down. 

Mr. Connolly: I asked a question, and I was answered. 

Unidentified Speaker: And a great number of agents combine it, 
in small corporations, with reasonable compensation, and say that the 
purpose of the payment of the compensation is to avoid payment of 
a dividend and they threaten Section 102. 

Mr. George: May we hear from Professor William Vickrey of Co- 

Statement of William Vickrey 
Columbia University 
Mr. Vickrey: Well, I am going a bit far afield, but I'd like to start 
out by saying that in my judgment, if Section 102 is thought of pri- 
marily as a means of eliminating certain types of inequities on certain 
types of shareholders of closely held corporations, then I think that 
by itself it cannot accomplish this end. To try and patch up Section 
102 in this way is a little like trying to plug a couple more holes in 
a colander and hope to hold a little bit more water, when all the 
other holes are free for the water to run out. 

If, on the other hand, you look at Section 102 as one point at which 
you want to compensate foi a tendency of the tax structure to en- 
courage accumulations of earnings beyond the 
Function of 102 ° . . . . , , , ° ' A , . 

extent to which they would be accumulated in 

the absence of any tax, then possibly Section 102 has a role. But I 
think it is only in that latter function that I would be willing to 
consider the retention of anything that even looks like Section 102 
at present. 

Accumulations of earnings of a corporation can arise from several 
motives, one set of which I would call legitimate economic motives 
and two sets of which I would call extraneous, which should if pos- 
sible be eliminated. 

The first is the fact that the management of a corporation may 
have better knowledge of the opportunities for investment than its 


shareholders and at the same time the management of a corporation 
may feel that the cost of securing funds through Ugitimate Motlves 
the flotation of additional securities is unjustifi- for AccumuIation 
ably larger than the cost of merely retaining 

earnings. Retaining earnings has been a more economical method of 
securing new investment than flotation of new securities, in terms of 
saving of underwriting expense. Those are what I would consider the 
legitimate motives for accumulation of earnings. 

Among the non-legitimate motives I would place, first, the general 
tendency— which is often denied, but which I think exists at a sub- 
conscious level at least— for management to wish Non-Legitimate 
to extend their enterprise, and to render it more Motives 

secure against fluctuations, for the sake of re- 
tention of themselves in a position and expanding that position. Now, 
that may or may not be there in any given case, and perhaps many 
people here will feel that that is unimportant. 

What is more relevant here is that accumulation of earnings can 
be affected by tax motives. There is a saving in taxes through the 
accumulation of earnings, regardless of whether this enters into the 
conscious calculations of the management, re- Tqx Motiyes 

gardless of whether the corporation is widely 
held or narrowly held, regardless of whether the stockholders are sub- 
ject to high income brackets or low income tax brackets, and especially 
regardless of whether there are any legitimate business reasons for 
accumulation of the earnings. 

Now, for these general, widely held corporations I think that it is 
possible to impose a tax which will be substantially a countervailing 
levy which will just about offset these tax motives for the bulk of 
corporations that are fairly widely held and Countmailing Levy 
whose position doesn't differ too much from Suggested 

what you might say was the average position. 

This offset could be provided by the tax that I suggested at the begin- 
ning of the session, namely, a tax of 2 per cent, for example, of the 
accumulated undistributed earnings each year. 

It would operate somewhat like this: Suppose that the average tax- 
payer of a corporation is subject to a 50 per cent tax bracket, and 
suppose that we figure on a 4 per cent rate of interest, at which we 
would be willing to allow the corporation to borrow from the gov- 
ernment, or at which it could borrow in the market on good security, 
at any rate. Then if this corporation were to retain $1,000,000 worth 
of earnings instead of paying it out in dividends, for a period of ten 


years, and then distribute a dividend of the earnings after ten years — 
what happens is that the stockholders, instead of paying a 50 per cent 
tax of half a million now, will have the use of that money for ten 
years substantially interest-free, and will have to pay their tax only 
when the dividend is finally distributed. Now, it might be possible to 
argue that that borrowing from the government would be a legiti- 
mate aid to private enterprise. I would prefer to say that the corpora- 
tion would thus postpone the taxes of its shareholders by retention 
of earnings, and should pay a moderate rate of interest, on the tax 
so postponed, for the privilege, at a 2 per cent rate of tax on the 
aggregate of the undistributed earnings which would correspond to 
the payment of 4 per cent per year interest on the tax that is post- 
poned by reason of these earnings having been retained in the corpo- 

That, if we could do it, would take care of the average case. It 
would mean that for most corporations, other than the closely held 
corporations, we would have approximately eliminated the tax factor 
from the decision of management as to whether they should retain 
earnings or distribute them in dividends. 

For the closely held corporations, however, we cannot depend on 

any such relationship. Their stockholders may be in a higher tax 

bracket. More than that, the individuals to a greater extent than the 

average may be relying on the retention of earnings giving rise to an 

mM , opportunity to convert their income into capi- 
Supplementary 102 for , . J _ . _ r 

_, ..... tal gains taxed at the 2£ per cent rate. And com- 

Closely Held , . & . , , 1 ° r ,_ . _ , 

bination or these elements would probably mean 

that for a great many closely held corporations the 2 per cent rate 
would be inadequate and, indeed, any rate that we would feel justi- 
fied in applying generally would be inadequate. So that there would 
be a case, if we had such a general treatment for the general case of 
accumulation, for having a supplementary 102 treatment to be ap- 
plied where corporations are fairly closely held. 

I might possibly be willing to agree that this should be done, not 
by revising 102 but by extending the provisions of the personal hold- 
ing company supplement. That is a matter of technique. But certainly 
the personal holding company supplement provisions are not ade- 

. ' „ . quate for this purpose, in that it is much too 
Extension of Personal x _ . . , , i 1 , ,- 
,. ... „ easy for those with the personal holding corn- 
Holding Company __ . x , . , 

. . pany to arrange things so that that supplement 

does not apply in its present form. I believe it 

doesn't apply if a substantial part of the corporation engages directly 


in business, and even if it doesn't, it is probably possible, without too 
much difficulty, to get a sufficiently large group of wealthy persons 
together so that the provision does not apply. 

In any case, what would be needed, again, would probably not be 
a Section 102 in its present form of a penalty surtax, but I would 
prefer to see Section 102 made again a kind of countervailing levy at 
a different level. That is, instead of 2 per cent, which would probably 
be an appropriate rate for corporations generally with the average 
distribution of stockholders in the income tax Countervaning Levy 
brackets, we would have a higher rate which 
would apply by reason of the fact that here is a case where most of 
the stockholders are in the top brackets and where there is an expec- 
tation that a very substantial conversion of income into capital gains 
is likely to take place. So that, again, instead of having the kind of a 
tax base that we have been hearing about, we would have more 
nearly a 4 per cent annum rate or something of that sort. I haven't 
gone into this very thoroughly; the details need to be worked out. 

In any case, I would like to state rather emphatically that, to my 
way of thinking, what is done with the surplus, how it is invested, 
questions of legitimate business reasons, or propriety of the accumu- 
lation of surplus, are completely irrelevant for ^.^ ReQsons 
this purpose and should be strictly ruled out. irrelevant 

Not only are they irrelevant from the stand- 
point of taxpayer equity, but they tend to produce the kind of waste- 
ful investment of which we have had several instances cited both 
today and in the fact-finding record. 

As soon as we introduce any sort of notice of legitimate business 
reasons two things happen: First, the tax becomes ineffective as a 
means of restoring equity, because taxpayers, I think, can exercise 
sufficient ingenuity, if they are scared enough, to devise some color 
of legitimate business reason for their investment. What is going to 
happen is that the people who are really trying to avoid tax will be 
successful because they will be willing to undertake sufficient com- 
mitments to give color of legitimate business reasons; whereas a corpo- 
ration that does not have tax avoidance as its primary motive may 
find it is not able, or not willing, perhaps, to go to the expense of 
committing itself to the extent of establishing a legitimate business 

Therefore, any Section 102 provision, it seems to me, ought to be 
applied regardless of the legitimate business reason criteria. So, if we 
do that, we will have to have some other criteria to take its place. It 


seems to me that there ought to be some standard amount of accu- 
mulation of earnings that could be accumulated without question, 
and that if the accumulation goes beyond this amount the tax should 
apply regardless of such intangible questions as attempts to avoid, or 
expectation of engaging in a new line of business, or allowing for an 
expansion or a depression, or what have you. Otherwise, it seems to 
me, there will inevitably be occasion for uncertainty, litigation, and 

Now, again, I have not gone into this very thoroughly, but offhand 
it seems to me that some formula could be developed as follows: That 
you could say that no tax would be applied until undistributed earn- 
ings and profits since some base date, say 1940, have aggregated an 
amount which could be the sum of three factors: a fixed sum to take 

care of the small business, plus the amount of 
Possible Formula . , . , r 

capital invested since 1940 — amount of equity 

capital invested, preferably — to take care of the new business, plus, 
say, 50 per cent of the dividends paid since 1940, which could allow 
for a reasonable rate of growth. Now, it may be said that this does 
impose a sort of a ceiling on the rate of growth or of reinvested earn- 
ings that one corporation could achieve, and I think there is some- 
thing to be said for this as a social policy. That is, certainly it is 
legitimate for a small business, especially, to grow out of undistributed 
profits and even for a fairly large business to grow not too rapidly 
out of undistributed profits. But there is certainly a case to be made 
for saying that you should not allow one corporation to pre-empt for 
itself more than a certain share of the pool of equity capital without 
subjecting it to some sort of market test. 

Discussion of Statement by William Vickrey 

Mr. Gornick: May I ask this, Mr. Vickrey? What is your purpose: 
to raise revenue or to penalize business? 

Mr. Vickrey: My purpose is to see to it that, as far as possible, 
business decisions are made in the same way that they would be made 
if the tax were not present. 

Mr. George: May I ask this — as a question of fact: Would your 
view still hold if the surtaxes were lower? 

Mr. Vickrey: Individual surtaxes? 

Mr. George: Yes. 

Mr. Vickrey: I think the question of the height of the individual 
surtaxes is quite a different question. 


Mr. George: Well, do you think there would be the necessity — 
the same necessity for your view if the surtaxes were lower? 

Mr. Vickrey: Oh, yes. 

Mr. Duiker: Would your view still hold if there were no taxes? 

Mr. Vickrey: Well, the individual tax, even an individual normal 
tax of 20 per cent, would give rise to the incentive that I speak of. 

Mr. George: But I was raising really a question of degree. That is 
to say, those incentives would be far more pow- |ndiyidua| ^^ 
erful with the surtax at its present level than in 
the case of a flat moderate rate such as you now suggest. 

Mr. Vickrey: Yes, well, the difference would lie in that I would 
still suggest the annual undistributed profits tax with a lower rate, to 
correspond with the lower individual rate. 

Mr. George: The thought back of my question was that there 
would probably be much more willingness on the part of corporations 
to defer to the market were it not for the penalties that stood between 
them and the market. 

Mr. Vickrey: Well, if you're thinking of the costs of going through 
the market — there are two kinds. One is the essential overhead cost 
involved in going through the market — the sales commissions, and 
everything else — 

Mr. George: I didn't mean that. 

Mr. Vickrey: You mean the individual surtax? Well, I would say 
flatly that if you want to plead that as a reason for allowing undis- 
tributed profits to remain untaxed, you are indulging in a kind of 

Mr. George: Oh, no — I'll put it another way: I am matching one 
artificiality with another. 

Mr. Vickrey: No, what I would say is: If you are pleading that 
the savings of the wealthy should be allowed to be reinvested without 
paying surtax- 
Mr. George: No, not without any surtax. Again I am raising the 
question of — 

Mr. Vickrey: Well, with a lower surtax — I will still argue the case 
with you, but I will concede that you would have an argument. If you 
say that the savings of the wealthy are to be allowed to be reinvested, 
free of surtax, only if this is done through the form of retention of 
earnings by corporations, then I say that is an unjustifiable distinction 
just the same way as if you were to argue about a tax on automobiles. 
If you argued with me over the rate of tax to be applied to all automo- 
biles, then we will be able to argue with each other. But if you argue 


with me that the rate of tax on automobiles is too high and that you 
want special exemption for Buick, why, I say you have no case at all. 
I say that there is no case at all for saying that savings of the wealthy 
should be allowed to be reinvested only when this is done in this 
particular form. I should not try to prove such a case. 

Mr. George: All I was trying to do was to bring out what I 
thought to be the influence of the present tax structure in creating the 
situation that you were trying to remedy through a better form of 

Mr. Vickrey: Well, if you are implying, in effect, that surtax rates 
are so high that if they were applied to all income — that is, if we 
did compel all earnings to be distributed — that there just wouldn't be 
enough left to supply equity capital, then I would say, if you were 
able to maintain that point, that the remedy is to lower the surtax 

But I do not see that there is justification for lowering, in effect, the 
rate on one particular form of reinvestment and not on all forms of 

Mr. George: Well, I am not trying to maintain any point. I was 
merely trying to clarify one issue, and find out how you would adjust 
your formula to different tax circumstances. 

Mr. Vickrey: Yes. Well, I think that issue is clear. I don't myself 
believe that in fact it is so, that the surtax rates are so high as to 
produce this result. But I would be willing to concede that others 
might believe differently and, if they do, that that is perfectly ac- 
ceptable as a general principle. 

Mr. Slitor: Well, if your annual tax on retained earnings would 
continue, even in years in which a corporation had no net income, so 
long as it continued to retain these earnings, the effective tax would 
be equal to the capitalized value of this annual tax. 

Mr. Vickrey: In effect, it is exactly as though you said, "Well, there 
will be a tax on these retained earnings — " 

Unidentified Speaker: Equal to the capitalized value of this annual 

Mr. Vickrey: Well, not quite. Let us suppose that these retained 

earnings are distributed to stockholders now. 

The government would collect such and such a 
Equivalent to _. . ,, . . u , 

; tax. The government is not going to collect this 

a pi a ize a lie ^ — instead of collecting this tax now, the gov- 
ernment is going to lend the money back to the corporation at 
4 per cent. 


Mr. Slitor: Yes, but if you capitalize this 2 per cent or 4 per cent 
annual tax, and treat that capitalized value as the tax, as equivalent 
to a one-shot undistributed profits tax, it would seem to be rather 
steep if the corporation intended to retain those earnings. 

Mr. Vickrey: Well, it is exactly the same as though the corpora- 
tion had paid the earnings out in dividends, and the stockholders had 
then paid the tax, and reinvested what they had left in the corpora- 
tion. Then the government turned around and lent the corporation 
the amount of tax it had collected, and charged 4 per cent a year. 

Mr. Slitor: You would get a sum very close to the amount of the 
undistributed earnings, wouldn't you? The tax is a certainty. 

Mr. Vickrey: Well, I was assuming that 50 per cent average mar- 
ginal rate. Perhaps that is a bit high — perhaps I should assume 40 per 
cent for the shareholders. But if you take $1,000,000 undistributed 
earnings, and assume that, if paid out, they would pay $500,000 tax, 
then what happens is that the stockholders have $500,000 left over 
with which to buy additional stock, and the government lends 
$500,000 back to the corporation. 

Mr. Slitor: If the corporation plowed back $1,000,000 in perma- 
nent form, permanent plant improvement, and they thereby were 
required to pay a tax of $20,000 a year, or 2 per cent, or $40,000 a 
year at 4 per cent, indefinitely — it would be the same as though they 
had assumed a liability to pay an annuity equal to that amount. And 
wouldn't the cost of such an annuity be almost equal to $1,000,000? 

Mr. Connolly: Well, at 4 per cent, in twenty-five years you would 
have paid in $1,000,000. 

Mr. Vickrey: Well, what I want to do is to say to the corporation, 
"You will be put in about the same position as you would have been 
if you had paid out all your dividends currently, stockholders had 
paid the surtax, and you had had to go out and borrow the additional 
amount at 4 per cent." 

Mr. Connolly: Well, but you cannot tell that, because of the dif- 
ferent tax brackets stockholders are in. 

Mr. Vickrey: That's right. And you won't be able, on this basis, 

to do justice to the individual stockholders. But from the point of 

view of the management, considering the in- ... ...... 

_' , ° ' , ° . Unjust to Individual 

terests 01 the stockholders on the average, by -.,,.. 

._ _ , , ' , . ? , Stockholders 

and large — if the average stockholder is in the 

50 per cent bracket, it will matter very little whether they pay out 

the dividends and raise the new capital, or whether they raise the new 

capital without any underwriting expense. 


Unidentified Speaker: Well, how is your point affected by the fact 
that they are not in the 50 per cent bracket? 

Mr. Vickrey: Well, if you say that the taxpayers are in a lower 
bracket, then I will consent to a lowering of this rate. But from an 
administrative point of view, you can't do anything but strike a rough 
average — I would say, very rough. But in a corporation like General 
Motors, for instance, what is the average marginal rate that its stock- 
holders pay? Your guess is as good as mine. The 50 per cent tax is 
high for that. 

Mr. Duiker: When you take into consideration hospitals and nego- 
tiated pension funds, and everything else, in which money is invested 
— in your blue chips — a great number of your shareholders aren't sub- 
ject to tax at all. 

Mr. Vickrey: That would be a matter for professional investiga- 

Unidentified Speaker: But if we presume— 

Mr. Vickrey: I don't mean you should have to do it each time. 
The idea is that you would investigate once and for all, determine a 
suitable rate, and then that rate would apply to everybody. 

Mr. Richardson: But what I don't get at all is — and it may be I 
am losing sight of very sound economic theory in trying to figure the 
practical problem — suppose we had exactly the same situation which 
you proposed (and I'm not discussing the merits and demerits of it) 
— suppose we had it. In that particular situation, where three stock- 
holders owned all of the shares of stock and they already were in the 
top surtax bracket, would it be to their advantage to allow the corpora- 
tion to retain the money, and go right ahead? 

Mr. Vickrey: In such cases, I would turn to Section 102. 

Mr. Richardson: That brings you right back to Section 102 again, 
doesn't it? I don't mean to be impertinent, but the whole theory 
which you are propounding is the theory of an 
equitable charge upon the retention of earn- 
ings but which would not in any way affect 102 
as such, because we would go right back to another 102. 

Mr. Vickrey: The question, really, is this: There is a general level 
of a charge for the privilege of retaining earnings which is applicable 
— which would be a countervailing levy for the bulk of corporations. 
There is a higher rate that would be a surcharge, a suitable counter- 
vailing levy or surcharge for these special 102 closely held corpora- 
tions. Now, the question really amounts to this: If you don't have 
some countervailing levy for the large bulk of corporations, then you 


have a rather big jump between people who will be subject to 102 
and people who are subject to nothing at all. 

Mr. Richardson: That is the impression I was getting. That is the 
reason I brought it up in relation to myself, because as I see it, what 
we are doing in discussing 102 from a policy Undistributed 

point of view (if we accept the proposition that 
you present) is to say that one sound policy to 

eliminate some of the difficulties of 102 would be the imposition of 
an undistributed profits charge that would narrow the field of appli- 
cation of 102. 

Mr. Vickrey: That's right. Not only narrow the field of its appli- 
cation but reduce the differential at the margin between the cases to 
which 102 does not apply and the cases to which 102 does. 

Mr. Richardson: Well, then, if we could find an ideal under your 
theory, we would completely eliminate 102? 

Mr. Vickrey: Yes. 

Mr. Richardson: But there can't be an ideal because of the vari- 
ance of holdings and percentage of holdings and Variations Among 
income tax brackets of the stockholders. _ kh Id r 

Mr. Vickrey: That is substantially it. The 

reason for proposing a general scheme is the assumption that there is 

a fairly wide class of corporations for which the . 

; r Assumption as to 

average income tax rate of the shareholders runs , 

& General Run of 

within a moderately narrow range, for which we 

can find a single percentage which, when applied 

to the undistributed earnings, will work rough justice. 

Mr. Connolly: Is your recommendation based upon the prem- 
ise that any time a corporation makes a dollar, and, after it pays 
the 38 cents on the dollar (assuming the present rates), and retains 
62 cents, it immediately owes somebody a tax and that somebody is 
Uncle Sam? Is that your theory? 

Mr. Vickrey: The theory is not whether they owe or don't. I don't 
pretend to defend the corporation income tax. . . 

The proposition is simply this: That in deciding t x p r 

whether to retain the earnings or pay them out 

in dividends, the management ought to be in a position where they 
can make that decision without having tax pressure. Now, if — 

Mr. Connolly: There will be pressure from the stockholders if 
they retain it under your scheme, at 4 per cent 
or 2 per cent, either one. 

Mr. Vickrey: Well, the stockholders on the average will be gain- 


ing through the postponement of their tax liability in an amount 
which just about corresponds to this tax that the corporation is pay- 
ing. If I am a stockholder — going back to my 50 per cent assumption, 
which I'm willing to modify — if a corporation has $100,000 of earn- 
ings and it pays it out to me in dividends, I'll have to pay a $50,000 
tax. Now, if they keep it in the company for ten years and pay it out 
to me ten years later, I'll have to pay the $50,000 tax only later on. 
In the meantime, the company will have been paying $2,000 a year. 
Now, that $2,000 a year which the company has been paying is the 
interest that I pay for the privilege of having that $50,000 for the 
ten years and paying the tax later on. 

Mr. Connolly: Would management have any more freedom of 
action under your scheme than they have under the present law. 

Mr. Richardson: They will have more freedom of action in that 
they will have about twenty-five or fifty per cent more decision to make, 

..... , _ , so that they'd have more freedom of action and 

Additional Burden J 

more room. It seems to me you re pyramiding 
on Management ' r/ _, 

terribly the problem 01 management. The per- 
fect company whose stockholders are paying this average rate, what- 
ever it is that you determine upon, 50 per cent or 45 per cent, and 
will keep their stock and maintain it at that level, won't have a 

But you're not going to find that average company. Stockholders are 

eroinsr to be payinsr more or less; some stock- 
No Average Company 

holders more and some stockholders less. You're 

going to have a terrible pressure from the various classes of stock- 
holders — much more than you have now. 

Mr. Gornick: Try to apply your case to Mueller Macaroni Com- 

Mr. Vickrey: Well, that is rather an anomaly. 

Mr. Gornick: How would you apply it to Mr. Richardson's ex- 
ample — a corporation where a charity owns roughly 78 per cent and 
individuals own 22 per cent? 

Mr. Vickrey: Well, perhaps the charity could use the dividends. 
I don't know. But I don't see any particular reason for making an 
exception merely because a charity owns the company. 

Mr. Austin: And distribute to the charity for reinvestment? 

Mr. Vickrey: Well, if New York University and the Mueller com- 
pany can get together, the only result really will be that the Mueller 
company can distribute its dividends and New York University can 
buy more stock. That's perfectly simple. 


Mr. Richardson: I would like to ask you this, Professor: Suppose 
we had that situation of an attempted ideal distribution, and we 
narrowed the field of necessary application of 102, but we still had 
to have a type of 102 for those cases with a few stockholders in high 
brackets. Would the present type of 102, what we presently have in 
mind, apply — with its present faults of administrative difficulties? 

Mr. Vickrey: It's a sure saying that no doubt 102 as it now is will 
be modified. I would say I think I would prefer m W|j| Bg Modified 
to throw it out the window. 

Mr. Gainsbrugh: It seems to me you want to substitute another 
criterion for those already existing for 102. You want to use the cri- 
terion of size as a determinant, with the idea in mind that the larger 
the corporation, the less the pre-emption (as I remember your phrase) 
of private capital. 
Mr. Vickrey: Yes. 

Mr. Gainsbrugh: Which is, I think, another criterion from those 
currently used. 
Mr. Vickrey: Yes, it is quite a different criterion, and I — 
Mr. Gainsbrugh: With a different motivation in mind? It is a 
social motivation. 

Mr. Vickrey: It is a social motivation. It is also a feeling that if 
102 is thought of as redressing equities among . 

individual stockholders, then "legitimate busi- 
ness reasons" is absolutely irrelevant. 

Mr. Gainsbrugh: You substitute other criteria. 
Mr. Vickrey: The criterion that I would like to substitute is to 
say, in effect, as a matter of individual equity, well, we will allow indi- 
viduals to get away with a certain amount of use of corporations as a 
device for lightening their individual tax burden, but no more. We 
hope that we will make this margin large enough . 

to cover the bulk of legitimate business expan- 
sion. But this will be a pretty rigid limit specified in terms, as I say, 
of flat amounts proportionate to capital and proportionate to divi- 
dends paid. That is, you remove this tax entirely from dependence 
upon whether or not a management is going to invest this, or enter 
some orders that it doesn't really need, and so on, in the hope of get- 
ting away from Section 102. That is, any scheme that has this legiti- 
mate business reason as an element is going to have this wasteful im- 
pact upon business decisions. I don't see how you're going to get 
around it. 


Mr. Connolly: How would you modify 102 to coordinate it with 
this new provision? 

Mr. Vickrey: Well, in two or three ways, but perhaps the simplest 
way is merely to say that you have a penalty tax or, preferably, a 
countervailing tax at a fairly high rate — say about 30 per cent or 
40 per cent — on all of the undistributed earnings in excess of this 
standard that is set, which I set tentatively at 
$20,000 plus the invested capital plus half the 
dividends. That is, a new corporation can reinvest earnings until it 
has doubled its original investment, without penalties. And then it 
can keep on increasing, provided it pays out two-thirds in dividends. 

Mr. Connolly: Professor, don't you think you are falling into the 
same error that the judge did in that World Publishing Company case? 
He looked on the wrong side of the balance sheet, looked at the sur- 
plus rather than to find out what it was invested in? 

Mr. Vickrey: This is an equity affair, you see. If you're treating it 
as a tax on misuse of funds — 

Mr. Connolly: Well, that presupposes that the moment you make 
a dollar, you owe the government some tax on it, regardless of what 
you do with it. 

Mr. Vickrey: If you want to say that you want to have a spendings 
tax, I'll go along with that. 

Mr. Connolly: No, I do not go for that at all. I just do not concede 
the equity argument. 

Mr. Vickrey: Oh, well, if you have an income tax, then if a per- 
son has a dollar of income, whether it is accrued or uncertain or what- 
ever, he owes the government a part of it. If you don't like that kind 
of a tax, well, by all means, let's go to a spend- 
pen mgs .^ ^^ which I would be willing to support. 

But the point I'm making is: If you're going to 
tax the savings of an individual, then we ought to tax those savings 
whether they are left in the corporation or whether they are taken out 
and invested in something else. 

Mr. Austin: In other words, the underlying proposition is: That 
income should be taxed at the same rate whether a corporation has 
earned it, or an individual. 

Mr. Vickrey: And it ought to be taxed — 

Mr. Duiker: — unearned increment whether it is — 

Mr. Vickrey: Yes, eventually. 

Mr. Duiker: Not eventually, immediately. 

Mr. Vickrey: Well, if you defer it, that is a different question, but 


for administrative reasons you probably can't tax it immediately. But 

at least, deferment ought not to be allowed to go along indefinitely. 

Mr. Connolly: Well, twenty years ago I might have agreed with 

you, but I've loner since come to the conclusion , . 

' . ° , . . . Integration of Corporate 

that when we attempt to sret the integration or ...... 

_ , . ' ,. . , , . , . and Individual Taxes 

the corporate and the individual taxes, it s 1m- , . , , 

practical and never will be done, politically or 

otherwise. That's the conclusion I've arrived at, after twenty years. 

Mr. George: Mr. Austin is an old hand in this field, and we want 
to hear what he has to say. 

Mr. Austin: Well, I have accomplished this much this time. On 
the preceding panel I was in a delightful position: I led off. 

Mr. George: I know. 

Mr. Austin: And everybody took their shots at me. So now I can 
do it the other way. 

Statement by Maurice Austin 
Klein, Hinds & Finke 

Mr. Austin: Let me say first that I am proceeding entirely on the 
theory that the basic premises of our present system are to remain as 
is, and more specifically in relation to this question, that it is one of 
the basic premises of our tax setup, that a corporation is to be subject 
on its income to only the corporation rate, so long as its legitimate 
business requirements require the money in the business, and avoid- 
ance of taxation is not the basis of the retention. 

There have been a number of proposals made for improvement of 
Section 102 and its form and administration. Many of them I go 
along with, at least to the extent of saying that I find no objection 
to them — such things as shifting the burden of proof to the Com- 
missioner, which I feel has psychological value at most (although that 
may be an important value), and such proposals as excluding certain 
classes of corporations from the operation of the section, either by 
reason of size or distribution of stockholders. 

I am somewhat hesitant on any formula which would exclude from 
the operation of this section such corporations as pay over a certain 
amount in dividends, because I think it is prob- 
able that any such legislation would set up so 
, . , . ' - ,. ., , , t Percentage of 

high a ratio of dividends as to cover only those ^. . , , 

. , 1 . , . , ; . Dividends 

corporations that probably have not been af- 
fected by the problem in any case. And secondly, by almost unavoid- 
able inference, if you set a level of that type, all the corporations that 


are under that level immediately come under worse difficulties than 
they are under today. 

There are other suggestions. One of them (this is also a fringe 

proposition) is a so-called two and a half month 

Two and a Half . . , ,. , . . r . . . * 

provision, by which a corporation, it it is to be 
Months Provision , , . . ,. r ,. . 

taxed under 102, is given credit for any divi- 
dends paid within two and one-half months after the end of the year. 
I think primarily there are two problems involved in this. One is 
the seriousness of the penalty that is imposed, and the seriousness must 
be weighed not only from the viewpoint of proper penalizing of com- 
panies that are really guilty of proscribed purpose — not only of making 
it heavy enough to have it compulsive, but you must bear in mind 
that there are a number of cases that are going to be touched by 
Section 102, which shouldn't be. No matter what we do, they are not 
going to be able to get out of the factual circumstances. 

It seems to me the main relief that can and should be given here 
is by way of a deficiency dividend credit. Whether it be to the extent 
of relieving the corporation for the full amount of the surtax if it 

pays out an equivalent amount of dividends in 

Deficiency Dividend r . r . T -, ,. * „ M „ 

a later year, or for 90 per cent, I don t know, 

or care too much. I do think that it bears down 
pretty heavily to have this penalty tax imposed and then have the 
corporation or its stockholders also pay some further tax if there is 
a later distribution of the already diminished earnings. I think it 
would do a great deal toward solving still another problem, and that 
is the possibility of the liability of directors and minority stockhold- 
ers under Section 102 tax, if imposed. The ability to get out of it by 
paying the necessary amount of dividends would almost clear up that 

I still haven't touched what I think is the most important problem 
in this whole area. You can't resolve all problems and uncertainties 
here. The worst one to my mind is the one which stems out of the 

so-called immediacy doctrine, whereby a corn- 
Immediacy Doctrine Is ^^ ^^ ^ sa£ety retain eamings> if it 

Worst Problem ^ definke needs which are indefinite as to time 
of consummation, or indefinite needs (such as a reserve against future 
depressions, a reserve against possible future expansion of the com- 
pany), which like all companies it would want to go into at the proper 
time, and the like. 

Mr. Duiker's draft, or the draft of his committee, is the first draft I 
have seen anywhere in writing that even attempts to deal with such 


problems by substituting for the present criteria of reasonable needs 

of the business what he calls reasonably foresee- 

able needs of the business. Whether that does it * 

. . Foreseeable Needs 

or not, I wouldn't be prepared to say at this 

moment. I think that something ought to be done by way of legisla- 
tion which would make it incumbent upon the courts and upon the 
administration to regard as a relevant factor in the case future needs 
of this type, without that immediacy requirement, as long as they are 
reasonable and as long as the court or the administration is satisfied 
of the bona fides of the situation. 

Now, that pretty well covers what I have to say, I think. 

Discussion of Statement by Maurice Austin 

Mr. George: Questions? 

Mr. Austin: I think in one way or another, most of these things 
have been covered as we have gone around. 

Mr. Connolly: Mr. Austin, in your day-to-day work on this sec- 
tion, do you have any great difficulties with this problem? The X 
Corporation started a $10,000,000 building program in 1948. For some 
twenty-five years it has earned a profit each year. Its directors decided 
not to gamble on the future and they retained seventy-five per cent 
out of 1948 earnings. The earnings for 1949 and 1950 when the pro- 
gram was completed were sufficient to finance the entire program. 

Mr. Austin: Well, of course, we have that World Publishing Com- 
pany case. In that one instance the court held that it was not a 
reasonable basis for withholding earnings because their expected earn- 
ings would be enough to cover the situation. I think that decision was 
a very unfortunate one. I think generally that 
in all these situations posing that question, the 

hindsight which is available at the time the issue „. , . , L 

7 , r on Hindsight 

arises becomes the all-important factor. You can 

set forth all the documents and all the plans you want; when the 
examination occurs three years later, and the tax people are there, the 
question is what actually has happened. If the company actually has 
gone ahead with the program, at least in very substantial measure, 
and finding itself with earnings in later years beyond its requirements, 
had paid out dividends at that time I don't think there's any problem. 
The problem arises in those cases where the subsequent earnings 
have not been available for dividends, where rising costs or other con- 
tingencies or perhaps even general business conditions cause the com- 
pany temporarily to postpone the building program. There you begin 


to get into trouble. The feeling always has been in those cases that 
there is not overmuch to be concerned about, i£ the evidence is quite 
clear as to the reality of the program in the first place and, in the 
second place, the reality of the factors which cause the abandonment. 
If it is merely a temporary postponement, that's one thing; if it's a 
permanent abandonment, such a case would seem to require some 
dividend policy at that time. 

Mr. Sonderman: That is, if such a contingency arose. 

Mr. Austin: Yes. 

Mr. George: Well, that is one of those uncertainties that you gen- 
tlemen speak about that seems to have given a good deal of trouble. 

Mr. Austin: It's a greater difficulty in cases where they have such 

a program, which perhaps they've nurtured for quite a while. They 

say, "We need money for the time when we're going to do it; we 

intend to do it, but now is just the wrong time 
Immediacy Problem , . _._. , . . . .„ . , , 

to do it. When the right time will be, we don t 

know. But we don't want to have to go out and borrow funds at that 

time." Now, that is the kind of case where this immediacy problem 

hits you right in the eyes. 

Mr. Sonderman: And in a good many cases, on good faith, a num- 
ber of them were held off because of high costs. And because of sitting 
back and waiting for costs to come down, they invoked this section 
and had to pay it. What could they do? I've seen quite a number of 
those situations in which this immediacy problem has entered. 

Mr. George: When you say "immediacy," you have no particular 
time range in mind, do you? 

Mr. Austin: I only have in mind what the courts have said, that 
unless the expenditure is to be made within the reasonably immediate 
future, it is not the kind of thing that justifies retention of earnings. 

Mr. George: Yes, but I'm not talking about what went before. I'm 
talking about what you would substitute as a concept. 

Mr. Austin: What I would substitute as a concept is the justifica- 
tion of retention of earnings in good faith, as against needs which 

may be in the future, in the foreseeable future. 
Justification of ,__. . . , , r . . TAT1 _ ^, 

. That is a shorthand way of putting it. Whether 
Retention in Good Faith . . „ ' [ . . . , 

it is effective as a matter of legislative language, 

is another thing. But I think the word expresses it pretty well. 

Mr. George: Would the regular use of funds over time be a proper 

Mr. Austin: You mean in this company? 

Mr. George: In any company. 


Mr. Austin: I don't know. Individual cases can vary so much from 
a norm as to make that of very little general value. 

Mr. George: What I was getting at was this: That if the company 
has an historic record over a period of years of having invested, would 
that be evidence of the reasonableness of the retention? 

Mr. Austin: Oh, I think it is today. I think its dividend record 
and its past record of what it's done with accumulations is today re- 
garded as evidence. The only thine: is that even ^. . , , „ 
• i- ,- t j -r , , Dividend Record Now 

in the light or such a record, it the supposed _ . , , 

° _ ■,..-. r i • Considered as Evidence 

requirements for present excess liquid funds is 

for something in the relatively indefinite or postponed future, the 

courts still in a number of cases, in a sufficient number of cases to 

create an unfortunate pressure, have imposed the tax. The World 

Publishing case is the outstanding case. 

Mr. Duiker: I would say also that the courts haven't given very 

much weight to past policy, because in a large 

number of the litigated cases it was disclosed that _. kl , ... . . 

, , , , lilt- r G,ven Much Weight 

corporations had expanded and had a history ot _ 

• -ru a ■ ■ u . u u a t0 Past Po,lc y 

expansion. The decisions nave not been based 

in the light of that past expansion, but it is the immediate — 

Unidentified Speaker: You're right. 

Mr. Duiker: Whether there are any commitments, which is an 
unfortunate way to construe this section. 

Mr. Austin: Or, to put it another way, to let that immediacy re- 
quirement override the others. 

Mr. Duiker: That's right. 

Mr. George: Well, that's what I was trying to get at. Even the 
way in which you answer my question allows it to survive. Because 
even though there was a record of payment over the years, it would 
seem from the comments that they are still likely to invoke the test 
of immediacy. 

Mr. Duiker: Along that line, could I add something to the dis- 
cussion at this point? I've taken up the cudgels for this committee pro- 
posal only because it was on the table. But when I originally ap- 
proached the problem, I had rather different recommendations. I 
think some of them may be pertinent at this point. 

One was to restrict the application of 102 to those companies that 

had undistributed earnings in excess of $100,000, _ , . „ . , 

. . , • , , ., Exclusion on Basis of 

or whose net capital assets were less than $2,000,- 

, - , , . T Earnings or Assets 

000, or to reduce the penalty m such cases. In 

other words, where you had a small amount of earnings and a small 


amount of capital, instead of imposing %*j\/ % or 381/^, be a little light 

on it. 

In addition to that: To have the Treasury publish a formula which 

could be used to determine the amount of liquid assets necessary for 

the operation of the business and for credit purposes. I have seen 

something done on that which was reasonably intelligent. To recognize 

the setting up of reserves at current replacement 
Publication of Formula . , ,,. r ,. ., , , . ' . 

costs, the levelling of dividends (that is, in a 

number of cases, if you could permit corpora- 
tions that are feast-and-famine corporations to retain earnings so that 
they can distribute a level of 3 per cent rather than 8 per cent in one 
year and then nothing for the next four or five years), and allow the 
setting up of a reserve for that purpose. To recognize long-term ex- 
pansion programs, both as to future and as to past record, so that 
could be used as some sort of a test. To take into consideration pen- 
sion benefits or plans — long-range plans for the security the employees 
get out of it. 

The next one was to establish a unit in the Bureau to which the 
taxpayers could apply for rulings upon submission of balance sheets 
and reasons described for the retention of earnings, with the require- 
ment that the statute would not apply unless the Commissioner 
ruled adversely within seventy-five days. He usu- 
ally would apply within seventy-five days before 
the end of the year. So that you could apply to some division in the 
Bureau — as you now go to Ralph Dayton on your recapitalizations 
and your mergers — to see whether or not you could get in the clear 
about a long-range expansion program, which would eliminate a 
great deal of the fear. 

Mr. Austin: All these things you are talking about are intended 
as regulations? 

Mr. Duiker: Yes. To limit the application of the section only to 
the year currently under examination, instead of piling up three or 
four years at one time. 

Another one: To give special consideration to businesses with a 

record of expansion, or apply the section only in those cases where 

there had been a continuous course of viola- 
Special Consideration . r - , u _ „ '*.„ 
tions, running for more than two or three years, 

ompames ^ t k at y OU wou id g e t rid of these sporadic cases. 

To give special consideration to those companies which in any year 

submit in full detail the dividend distribution to the Commissioner. 

Mr. Gornick: Would you add to that, to make it clear, that there 


is no question relating to the payment of debts and obligations in 
any one year? 
Mr. Duiker: Yes. 

Mr. Gornick: Regardless of legal liability? 

Mr. Duiker: I would think so. I think that would be pertinent 
because I know there are a number of companies — at least, I've dealt 
with a number of such companies— that have been very seriously in- 
volved in bank loans, and they struggle very desperately to get from 
under them. The experience has been so vivid ^^ p nt 

to them that they don't want to get into it again. 

One of the real problems you meet is the problem of corporations try- 
ing to avoid a debt obligation, and if they have one, they want to 
dispose of it just as rapidly as they can, so that they can use their own 
funds to finance their own business. 

Now, as I say, these were all recommendations. These are the things 
I thought we ought to consider seriously. They were more or less 
abandoned in the light of the recommendation that was made, be- 
cause the committee generally thought that a lot of these problems 
would be eliminated if you could reduce the hazard of your guesses 
and be allowed to litigate and be allowed to have a determination of 
the exact amount, with an opportunity to avoid substantially the 
penalty which was involved in a good many cases. I thought that 
there might be some value in these suggestions. 
Mr. George: I think there is very considerable value in them. 
Mr. Austin: Certainly I think that that type of direction of effort, 
mostly dealing with this immediacy problem, goes much more to the 
heart of this section than trying to deal with it by formula. 

Mr. Duiker: I do, too. That is why I was very interested in the 
things which you were saying, and that is why I said that, although 
I've taken up the cudgels for this recommendation, I think there are 
a lot of other approaches to the problem which eration of 

would call for the cooperation of the Treasury - TreQ 

and the cooperation of the Commissioner. I 

don't doubt that if they were approached fairly, we could come to 
some reasonable understanding and some reasonable program. Be- 
cause, as I say, the Treasury has under serious consideration an ex- 
pansion of the regulations. Now, whether they embody — 

Mr. Austin: It isn't the regulations at all. Whatever the Treasury's 
decision might be on the immediacy problem, faced with these de- 
cisions, they're almost bound to litigate those points. 
Mr. Duiker: Yes. 


Formulation of Policy Panel Recommendations 

Mr. George: Gentlemen, we have a problem. We have to make 

recommendations. I haven't been able, with my kind of shorthand, 

to catch the essence of each one of the ideas that have been brought 

out here, or the form of wording. I have felt that 
Panel . , . , . °. „ , 

, . in reapproachmg the question in terms of the 

Recommendations ,. . A± _ ° _ / 

list that we already have, those ideas would 

come out again. What is your pleasure on this? Is the best procedure 

on this to start going through these questions and see what form of 

wording we want to arrive at, in terms of the consensus? Is that 

feasible? Or what alternative is there? 

Mr. Austin: Is it your idea to have recommendations emerge if 
you've got a sufficient consensus, or is it the thought to attempt, inas- 
much as this is a panel session, to summarize the results of the panel 
and show the degree of consensus on various aspects? 

Mr. George: I should say that the second is an approach to the 
first and will reach the first where the consensus is clear enough. 

Mr. Duiker: May I offer this observation. The way I had the 
problem analyzed was this: There are two approaches to the prob- 
lem. One is to attempt a direct amendment of 
Amendment Versus _.,.-. . . , . 

_. ., . n , . Section 102. Ine other is to approach it through 

Clarifying Regulations . . , ' r f ** 

the Commissioner s omce, and see whether or 

not through clarifying regulations of the statute as it stands we can 

come up with some cogent changes. 

Mr. Austin: They may be two facets of one approach. 

Mr. Duiker: They might or they might not; I don't know. I think 
the Commissioner might accomplish a great deal by regulations and 
by administration. 

Mr. Gornick: Are we under an obligation, Mr. Chairman, to reply 
to each of these questions of the fact-finding panel? 

Mr. George: No. The suggestions were merely passed on to this 
panel as those that were uppermost in the minds of the fact-finding 
group when they were doing their job. This panel is on its own as to 
what it wants to decide. 

Mr. Austin: The point of my comments a few moments ago was 

this: If you get any group — whether it be this group or any other — 

you're going to find that by reason of experience or background or 

mental make-up or what-have-you, you're going 

to have ten approaches to this thing and you 

are never going to get any consensus as to which one is the best. I think 


the best we can do is to get a sort of feel from the discussion of what 
bases do produce the greatest consensus. 

Mr. George: All right, I will accept that. How do we go about it? 
Do we look at Question A and see what happens? 

Mr. Austin: I have an idea that if you just analyzed from the tran- 
script the discussion that has already transpired, you'd be able to 
make quite a good deal out of it. 

Mr. George: I had that possibility in mind, but I've also thought 
that we might be able to do more than that if we try. 

Mr. Gornick: I think if we went down through these questions, 
we'd really have a consensus. I believe they really cover about every- 
thing we have discussed. 

Mr. George: We may not be successful because the discussion is 
liable to burst out all over again, and make it difficult to get very 
far. But I see no alternative at the moment but to try. 

A. Procedural Changes 
1. Clarity 


Mr. George: The first question is: Is it possible and desirable for 
the Bureau of Internal Revenue to stipulate more exactly the condi- 
tions or purposes that would justify heavy retentions under Section 
102 and those that will not? 

Mr. Austin: That seems to be largely what I would call Mr. 
Duiker's approach. 

Mr. Gornick: I would certainly think they could. 

Mr. George: Detailed regulations? 

Mr. Gornick: Yes. 

Mr. Duiker: I would think certainly they should. 

Mr. George: Do you have any suggestions to build into that? 

Mr. Austin: I would add to it that it is not possible to cover all 

the important points, by that process. As I said , .. ^ . 

r r . i t • Immediacy Question 

before, the immediacy question would require a . 

statute. If that is taken as an all-inclusive an- 
swer, then it leaves the wrong impression. 

Mr. George: Is it possible to distinguish by illustration — those 
that can be taken care of by interpretation and those that require 

Mr. Duiker: Wouldn't it be easier to say that it is desirable for 
the Treasury to do that? Plus other things. I think everybody would 
agree to that. 


Mr. Austin: As part of a program, it is possible and desirable. 

Mr. Duiker: Yes, that's right. 

Mr. Vickrey: I would like to raise the question whether the result 
of such a stipulation might be to increase the amount that is devoted 
to uneconomic purposes. 

Mr. Austin: You mean by having artificial investments? 

Mr. Vickrey: Yes. If the Bureau stipulated too closely that this 

.«..,. kind of investment is a protection against 102, 

Effect of Stipulation on _ _ . . x ° 

. .,..,, does not that involve a temptation to the tax- 

Artificial Investments . , . , , . , 

payer to invest in that particular thing, whether 

or not he thinks it wise? 

Mr. George: Well, I think it is in part the addition of new dimen- 
sions to the existing standards. Now, for instance, we had a question 
here first of clarification, to which there can be the reply that the 
Bureau has already gone a long way in stipulating the kinds of condi- 
tions under which it will not invoke 102. Then immediately comes 
to mind the collateral question of immediacy. 

Mr. Austin: And the minute you bring that in, you tend to relieve 
this artificial immediate investment. 

Mr. Vickrey: If an adequate provision can be written. 

Mr. Austin: Of course, that doesn't call it a clear tax avoidance 
case for no better reason than that. They invest rather than distribute, 
but — 

Mr. George: Well, if it is interpreted in that way, including pur- 
poses that will justify heavy retention in liquid form without any 

.„ .. kl , ■ commitment being made, then I submit that 
Would Make 102 a 1 , . . & 

„ . , adoption of this proposal would make 102 a 

Dead Letter _ \ _ „ .* 1 . ^ 1 • 

dead letter. Except possibly as to holding com- 
panies. Now, it may be that you want to retain 102 on the books as a 
dead letter for window-dressing purposes, and I am not arguing 
whether or not that is desirable. But I think that is very likely what 
would be the result. 

Mr. Duiker: I think you could trust the 
Treasury Would Not , ' .. . .. . 

„ _ m Treasury not to extend itself too far if it ex- 

Go Too Far _ , \ _ . 

panded its regulations. 

Mr. Gornick: Solely within the discretion of the Treasury Depart- 
ment, I think it can, and I believe it would agree that it can, do some- 
thing to clarify the present situation. That is about all this is. Is it 
possible and desirable? I think the general consensus is that it would 

Mr. George: Do you care to illustrate? 


Mr. Gornick: I think Mr. Duiker gave quite a few points on 
which clarification would be possible. 

Mr. George: Here are some of them: Allow reserves for replace- 
ment cost; recognize long-term expansion record; establish unit in 
Bureau to which taxpayer could apply for rul- , 

ings; good unless voided by the Commissioner 
in seventy-five days; special consideration to con- 
cerns with a record of payments or expansion; special consideration 
for small business; allow repayments of debts or obligations. 

Well, now, those are blunderbusses in many respects. You couldn't 
— or could you? — put those down and say to the Commissioner, 
"Please clarify the extent to which you will take all of these special 
circumstances and purposes into consideration." 

Mr. Vickrey: Well, the question really in my mind was: Can you 
clarify this to the extent that would be really satisfactory to the tax 
practitioner, without at the same time setting Wou|d c|arification 
out a tax avoidance manual that would give the . . . 

person who wishes to avoid tax, instructions on ? 

how to proceed so that the retention of earn- 
ings will be recognized? 

Mr. George: Mr. Slitor made what I thought was a perfectly valid 
response a while ago, when he said that any time you have a discre- 
tionary act, which probably would be considered f 

desirable in the case of a problem of this sort, 

L Implies Uncertainty 

that you must have that uncertainty. The 

thought occurred to me when he said that, that, yes, that's true, but 

there still is a possibility of improving the standards of flexibility 

through making them more explicit than they were before. 

It is a question of closing in on the subject and not resting our 
decision on a choice of one extreme or the other. Now, that is the 
way I visualize the problem here, and that is the kind of a question 
I'm putting to you. 

Mr. Duiker: You see, the Treasury already did the reverse in this 
release they got out a few years ago, when they had the 70 per cent 
provision, and they gave the agents direction to analyze those corpora- 
tions where the stock was closely held. That was JQ ■ 
a scare feature, which is just the reverse of what 
we're proposing that they do now. I think that 
was its purpose after the war was over, because they were concerned 
that dividends wouldn't be distributed after the war. I think they went 
too far, and they have retracted a good deal of it. 


What we're trying to encourage is just the reverse. I think the Com- 
missioner could do that just as well as he could do the other. 

Mr. George: Well, let me try another possibility. Here you have 

the much discussed Bar Association proposal 
Reasonably . . . _ . .. , , „ r r , , 

, , . , , with its use of the term reasonably foreseeable 
Foreseeable Needs „ . . ' . 

needs. I his was proposed as a legislative amend- 
ment in order to clarify. 

Mr. Duiker: That's right — yes. 

Mr. Austin: That term is not a clear term. It is not a definite term. 
But it is something that definitely would require a court to give effect 
or to take into account — 

Mr. Duiker: I think it has been used in rate tests for railroads and 
utilities. I think that there is some reasonable degree of definiteness. 

Mr. George: Well, from the standpoint of the law, of which I can 
claim no formal knowledge, wouldn't it mean that whatever has been 
the interpretation of the provision adopted by the Commission in the 
past, that now it is expected to be somewhat more liberal? 

Mr. Vickrey: Well, it would mean that incidentally. I think their 
objective is not that, so much as to try to get some reasonable assur- 
ance that the kind of motivation that affects the 
Assurance for . . . 

businessman acting in good faith and lrrespec- 
Busmessman Acting . ._,-..-?, , . , ,„ 

. _ j P . . tive ol taxes, if there is such a thine: — that would 

in Good Faith . . . ° 

move him in determining whether or not to dis- 
tribute and if so, how much — all those factors, all those kinds of 
motivations, would be regarded as legitimate factors in determining 
if 102 is applicable. 

Mr. Austin: That is not the situation today. 

Mr. George: Couldn't the Commissioner reply that he does that 

Mr. Austin: He could reply anything. No, that may not be Bureau 

policy. That may be part of the human element 
Human Element in t , , . . . _ t . , 

. . . . . in administration. But a policy stated at upper 

Administration ■,-■,-,■, , , , 

levels helps to iron out the human element. 

Mr. George: Then, doesn't that carry us back to my suggestion 
that whatever his words had meant in the past, now they are sup- 
posed to mean something more? Isn't that what that clause means? 

Mr. Austin: Let's put it a little differently. Let's assume that the 
Commissioner, in making whatever statement he has on the regula- 
tion, intended just what we intend — let's assume 
. Court Interpretation _ _ . J _ . , . 

that lor the moment. In practice, it has not been 

so interpreted in the courts, with the result that what is needed now 


is a more detailed statement which will make clear just how the present 
statement should be interpreted. 

Mr. George: Martin, you've had a lot of experience in organizing 
viewpoints. What have you to suggest? 

Mr. Gainsbrugh: I was going to raise one suggestion with you, 
about your first attempt at clarification. It seems to me that the big- 
gest area of uncertainty, at least in my experience outside the field 

of practice, is: Are we or are we not within the . . „ 

r Regulation Concerning 

ransre of Section 102? Could you not get a re- . , . ,. .... 

° ' jt Area of Applicability 

statement, if only that, or perhaps some addi- 
tional clarification on just that particular point from the Commis- 
sioner on the question: Are corporations whose securities are widely 
distributed and publicly held excluded or included? 

Mr. George: That question is raised again by one of the sugges- 
tions made with respect to legislation. 

Mr. Gainsbrugh: Well, without the recommendation for legisla- 

Mr. George: Yes, regarding it that way. I was just making a dis- 

Mr. Gornick: Could the Commissioner possibly issue a regulation 
saying that Section 102 is not applicable in any case where, let's say, 
20 per cent of the stock is owned by less than five persons in any 
family group? 

Mr. Duiker: That would be legislative. 

Mr. Gornick: I think you'd have to ask Congress to do that. 

Mr. George: Yes. I would like to try and put this to the test, as to 
whether or not the various suggestions which were made by Mr. Duiker 
would be appropriate for inclusion in a list on which you wanted the 
Commissioner to give a more definite expression of intention? 

Mr. Gornick: Yes, I think that certainly some of Mr. Duiker's 
questions could be clarified. The present regulation permits, for ex- 
ample, a reasonable addition to a sinking fund ^ , „ . 

. . j 1. j tat ii r. ^ Z Debt Retirement 

to retire indebtedness. Well, how about the case 

where someone wants to retire all of his debt, and not create a sink- 
ing fund? 

Mr. George: Without regard to the purposes for which the in- 
debtedness was contracted? 

Mr. Gornick: Why, yes, presumably it must have been contracted 
for some legitimate corporate purpose. 

Mr. George: Oh, it might have been contracted for the purpose of 
avoiding surtax. Suppose a food company invests in a cement plant? 


Mr. Gornick: Well, how does the regulation specifically read now? 

Mr. Duiker: "Reasonable expansion purposes, for the payment of 
debt, for purchases — " 

Mr. Connolly: I don't think there's any prohibition on retiring 
your debt today. 

Mr. Duiker: Yes, there is. 

Mr. Connolly: Which one? 

Mr. Duiker: Supreme Court — Chicago Stockyards. 

Mr. Connolly: Oh, well, that is — 

Mr. Gornick: — wholly different. 

Mr. Connolly: Way, way off. 

Mr. Gornick: I believe that Mr. Connolly is right. The general 
feeling among practitioners is that there is no reason why a corpora- 
tion can't retire its legitimate debts. But there still is nothing in the 
regulation that says so. All it says is something about a sinking fund, 
which leaves other areas in the field of uncertainty and doubt. 

Mr. Vickrey: Well, there is the almost classical case of a small, 
closely held company that set up in the first place a substantial amount 
of debt which was owned by the stockholders, share and share. 

Mr. Austin: That would have to be dealt with separately. 

Mr. Connolly: We're talking about mortgages and bonds. 

Mr. Gornick: The case that I have in mind is one where a corpo- 
ration will borrow from a bank enough money to build a plant, when 
it first gets started or shortly thereafter, but it doesn't have the funds 
and it needs them for its legitimate expansion program. Or it issues 
debentures and raises money by debentures to build a plant, or some- 
thing of that nature. Then, later on, it hits a period when it has 
earnings by which it can retire its debt, although it may be in the 
form of long-term bonds. I think it should be made clear that there is 
nothing to prevent a corporation from paying off its obligations im- 
mediately, rather than waiting until they run their course. 

Mr. George: That's what you outline, don't you, Mr. Duiker? 

Mr. Duiker: Yes, that is a credit now, I think, against holding 
company tax. 

Mr. Gornick: I think that is so. 

Unidentified Speaker: Certain types of debt — pre- 1934. 

Mr. George: Well, gentlemen, I'm not trying to influence you to 

. say any particular thing. I am trying to find out 

Clarity of , . .,_ . . r 

. . . . whether or not you will aerree to the sayiner 01 

Administrative . . , ; , . & . , ; & 

certain particular things, and merely to express 

that best I received Mr. Duiker's suggestions. 


Now, would you care to have those listed under the head of an effort 
to improve the clarity of administrative standards? 

Mr. Vickrey: Well, I think I would be willing to approve it as a 
step towards weakening Section 102. (Laughter) 

Mr. George: I recognize that it's not my place to argue that point. 
It's the place of the panel to decide. But I do refer back to my com- 
ment of a little while ago, that the effort is really not that we have to 
take a position at one extreme or another, but whether there's any 
greater clarity possible without the outcome that you suggest. 

Mr. Duiker: One answer to it is, as I said before, that apparently 
the Treasury Department thought it feasible because they undertook 
the program at one time, and then abandoned it. I know they have 
some ideas about it. 

Mr. Austin: Did you ever take up with them the matter of an 

advance ruling? That sounds like a very good idea, except that how 

feasible it is administratively, I don't know. . , 

__, . , r Advance Ruling 

There are so many thousands 01 corporations, 

and I can visualize that section being flooded with requests and not 

knowing what to do with them. 

Mr. Gornick: Well, is there any reason to believe that they would 
not rule on a case now? 

Mr. Austin: I don't think they would. Under their ruling section, 
I don't think they would. You couldn't even get a Section 115 (g) rule 
even now, and this is much more difficult. 

Mr. Richardson: I don't know — there might be exceptions to that 
statement, but as a general rule, I'm quite sure they're not permitted. 

Mr. Austin: That may well be. But if not, naturally, I think there 
ought to be some place where the taxpayer could present his case. 

Mr. Vickrey: It would also raise a question as to what your ruling 
was worth, because in that kind of a request for ruling, you could 
always find additional facts which are relevant. 

Unidentified Speaker: How could you, even supposing that you're 
giving all the facts? You'd have to admit weakness in your facts, and 
it would presumably be so because — 

Unidentified Speaker: Nevertheless, I think it is a desirable type of 
machinery, if it happens to be feasible. 

Mr. Duiker: Well, an alternative suggestion was, in order to create 

unity of administration among the various col- 

, • , , 102 Cases Processed 

lectors and revenue agents, to have all 102 s . ,. 

, , ,. . . ° . -., , . by Same Division 

processed by one division in Washington. 


Mr. George: That comes later. We have that. 

May I ask the question this way: How many of you think that it 
would be possible and desirable for the Commissioner to enlarge upon 
his present releases on the validity of the conditions in Mr. Duiker's 
list, without undue damage to the purposes of the act? 

Mr. Vickrey: Can you leave out that last phrase, "purposes of 
the act"? 

Mr. George: I can't very well leave it out, can I? Unless you tell 
me to do so. 

Mr. Austin: I think it's possible — the probability is present in 
some of the minds here, some who have had experiences with rulings 
under Section 722 and some other sections, which seem to have run 
off on a different trend. 

Mr. Gornick: Anything the Commissioner would put out would 
be helpful. 

Mr. Duiker: Desirable, but you're really not going to get very 
much that's worth while. That's the answer. 

Unidentified Speaker: If you think it's worth making, but with- 
out including the closing phrase, "without undue damage to the pur- 
poses of the act?" 

Unidentified Speaker: I see no objection to putting that qualify- 
ing clause in. I think it can be done. 

Mr. George: Would you go along with that, "Without material 
damage to the purposes of the act?" 

Mr. Vickrey: Well, that you can't answer, because obviously it's 
done to such a small extent that it wouldn't be material in any event. 
But, leaving that out, I'd go along. 

Mr. Gainsbrugh: I refrain from voting on that. With Section 722 
in mind, now. I question whether the practitioner found that pro- 
cedure helpful. Viewing the proposal from the outside again, it would 
probably make for more complication than before. I don't know how 
much more you can anticipate than the broad language that we have 
had given us in the past. 

Mr. George: That's an opinion? 

Mr. Gainsbrugh: Solely on the basis of limited experience with 
the Section 722 bulletin. 

Mr. George: Well, I'm going to put it down — that a slight or small 
majority felt that it was possible for the Commissioner to clarify and 
so forth, without undue damage to the purposes of the act, and they 
have particularly in mind such questions as the following. And Mr. 


Duiker can rephrase them — after all, I only have references here — you 
all heard them and understand their import. 

Mr. Slitor: Of course, you exclude me from any participation in 
the recommendations. 

Mr. George: Of course. 

Mr. Duiker: It's just that you don't like to hear it. 

Mr. George: All we want is your experience, not your commit- 

Mr. Duiker: You might eliminate the word "possible," and say 

Mr. George: Suppose we let that pass? 


Mr. George: Would it be safe for government or some other agency 

to conduct a campaign of education for corpo- 

i • c i i t r Campaign of 

rate management as to the justifiable bases or 

accumulations under 102? 

Mr. Duiker: That is much the same. 

Mr. George: Much the same — yes. 

Mr. Gornick: That, I take it, does not mean "feasible." That is, 
I don't think it is a question of education or anything else, be- 
cause there is really an uncertainty. Nobody today supplies the client 
with any certainty, and even the government itself, with all its educa- 
tion, can't do it. 

Mr. George: May I demur, as a matter of official necessity? Be- 
cause the fact-finding panel spent altogether, I suppose, a couple of 
hours on that point — remember? — and I felt that there was a great 
deal of opinion and evidence offered to the effect that many of the 
decisions were taken by concerns because of lack of understanding of 
the tolerance that was allowed under the law. 

Mr. Austin: That's what I said before — that you could get a good 
result under the stipulation of conditions for retention, and the other 
will follow. 

Mr. George: Yes, I think that disposes of it. 

Mr. Austin: I think it does. 


Mr. George: Can the extent of personal director liability to pen- 
alty be further clarified? 

Mr. Duiker: As a lawyer, I would say no. 

Unidentified Speaker: — if you had a deficiency dividend. They 
could pretty well duck out from under. 


Unidentified Speaker: I don't know. If I were a stockholder at the 
time you didn't declare a dividend, and subse- 
quently you declared the dividend to another 
stockholder, I don't know whether you'd be 
ducking liability or not. 

Mr. Duiker: Of course, you might tend to minimize it. 
Unidentified Speaker: The liability is a derivative liability in favor 
of the corporation. I should think one of your stockholders could 
enforce that. 

Mr. Gornick: Well, the most I think you can say there, Mr. Chair- 
man, is that this is a question of substantive law. It would be de- 
pendent upon the law of each particular state. 

lon Under the tax law the most that could be done 

Substantive Law . . ... ~ , ,. , 

is to give some relief to the directors by means 

of a provision for a deficiency dividend credit, along the lines of the 

suggestion of the American Bar Association. 

Mr. Duiker: That about states it. 

Mr. George: Could the dividend be paid to stockholders as of 
record of the original year? 

Mr. Vickrey: No, that gives you the complication of adjusting the 
price at which the stock was transferred to the new shareholder, and 
adjusting capital gains and losses. 

2. Internal Review 

Mr. George: Should a proposed 102 deficiency be approved by a 
special section of the Bureau at Washington before the taxpayer is 
called upon to defend his position? You've talked about that. 

Mr. Gornick: I am just thinking out loud, now, and this would 
mean — as far as local administration — that once the Bureau in Wash- 
ington made up its mind, it would be a case for the Tax Court. Be- 
cause, obviously, nobody in the field is going to go contrary to a de- 
cision reached in Washington. I think that's so — don't you all feel so? 

Mr. Austin: Certainly it would be a strong tendency. 

Mr. Gornick: That's consideration number one. Now, number 
two, is it possible for Washington to pass on each one of these cases? 
In other words, wouldn't you have another thing similar to the 
Excess Profits Tax Council? 

Unidentified Speaker: No, timing would stop it because you're go- 
ing to have the question normally considered and a reasonable deter- 
mination made within a short period. You would have so many cases 
going in to this central group in a short period of time. 


Mr. Gornick: It might be feasible. I suppose it would be at the 
suggestion of the taxpayer. 

Mr. George: I wonder how many of these are now reaching Wash- 
ington? Isn't there Washington review on the revenue agent's decision? 

Mr. Gornick: I think not, generally speaking. 

Mr. Austin: No, if the revenue agent recommends it, it gets proc- 
essed in the regular way. 

Mr. Austin: Don't they review the ones in which they have rec- 

Unidentified Speaker: Yes, but after all the processing is gone 

Mr. George: What is the purpose of the post-review? 

Unidentified Speaker: Well, theoretically, the purpose is to assure 
uniformity of review from all the offices. 

Mr. George: Also for future reference? 

Mr. Austin: So there is no kickback. 

Mr. George: Well, there are some cases that have kicked back. 

Mr. Austin: Oh, yes. 

Mr. George: You are saying, then, that we do have a species of 
central review now? 

Mr. Austin: But that is after the local processing. Well, I think 
this is a movement in the wrong direction, from the general adminis- 
tration point of view. 

Mr. George: What do you all feel would be the result of any such 
procedure as this? Would it increase or decrease the number of pen- 
alties, increase, improve, or worsen the quality of the judgments, and 
accelerate or retard action? 

Mr. Austin: It is not going to change the law. I'd rather have it 
stand as it is, operate as it is, and not have this. 

Mr. Gornick: As I recall, the fact-finding panel suggested this in 
order to provide some remedy for the divergence of action being now 
taken in the field by various revenue agents. In Djvergence of Action 
other words, they said you would probably get ^^ 

uniformity of treatment if you had one Bureau 

make the decision in the first place, rather than reviewing all the ac- 
tions that are being taken by thousands of agents throughout the 

Mr. Austin: We had an Excess Profits Tax Council with local 

committees who were supposed to have been in- ..... _ 

rr Diversity With Excess 

doctrinated centrally, and you get this tremen- ^^ Jqx Counc|I 

dous diversity. 


Mr. George: Well, at any rate, I sense no strong feeling for this. 
If there is no strong feeling, to me that is equivalent to a negative. 

Mr. Gornick: Of course, if the first step were taken, further clari- 
fication, the necessity of getting uniformity of action would be mini- 

Mr. Austin: Of course. 

Mr. Duiker: Mr. Miller had one case — do you remember what he 
said about it? He said, "Further, there is, as most of us know, a Mr. 
Bentson in the office of the Bureau in Washington who devotes his 
time to the administration of Section 102. No one can talk to him 
without feeling great confidence in his judgment. If it were possible 
for Mr. Bentson to be the decider of each one of these cases, after the 
point has been raised in the local revenue agent's office, and if it were 
possible to insure that he would be free to exercise that judgment, the 
management could sit back and feel pretty easy that its honest judg- 
ment would be confirmed by authorities." 

Mr. George: Suppose Mr. Zilch replaced Mr. Bentson? We're talk- 
ing to a point of principle and not personality. 

Mr. Duiker: Well, that is exactly what he said. Then he says, "We 

who have been in Washington for years have observed that if a single 

Congressman makes a bitter speech attacking the Treasury for not 

Pressure b enforcing Section 102, almost invariably men 

_ like Mr. Bentson cease to be the deciders of 


policy. Higher-ups in the Treasury, having in 

mind the effect such criticism has on future votes, feel impelled to 

step in and tell such men as Mr. Bentson that different policies are 

to be put into effect." And Miller speaks with great authority. 


Mr. George: I'm passing it — O.K.? 

Unidentified Speaker: Yes. 

3. Timing 

Mr. George: Would it be feasible and desirable to allow corpora- 
tions to satisfy the requirements of Section 102 by additional dividends 
paid within two and a half months after the close of the fiscal year? 

Mr. Richardson: Yes, I think everybody — almost everybody — 
would agree to that. 

Mr. Vickrey: Are you going to exclude the dividends paid during 
the first two and a half months of the fiscal year? 

Mr. Austin: Oh, yes. If you use it one year, you can't use it again 
the next year. 


Mr. George: You can't use it twice — i£ that's your question. 

Mr. Austin: Perhaps it should be so worded. We have a precedent 
for that under the personal holding company act. Moreover, the same 
principle is now being put into the law — just last year — on contribu- 

Mr. George: The fact-finding panel was very much exercised on 
this point, almost unanimously. Everybody worries about it. 

Mr. Gornick: I think almost everybody would agree to it. 

Mr. Austin: Yes. 

Mr. George: Well, what do you know? (Laughter) 

Mr. Austin: Congress included? Then you'd get complete agree- 
ment on it. (Laughter) 

B. Criteria for Legislative and Administrative Rules 
i. Limitation of Area of Challenge 


Mr. George: I think the proposal that the area of challenge be 
limited is a very serious suggestion. We can make better progress by 
limiting ourselves to criteria for legislative and administrative rules. 

Would it be feasible and desirable to redraft Section 102 so that it 

would require consideration and policing of only those corporations 

whose dividend distributions need to receive the . , 

Closely Held 
attention of the government? For example, 

should 102 be made applicable only to rela- 
tively close corporations not mainly engaged in operating business? 

Mr. Gornick: Well, I think my answer to that would be yes. 

Mr. Austin: Naturally. (Laughter) You said that before. 

Mr. Richardson: I agreed with you before and I still agree with 

Mr. George: Do you think there would be any political feasibility 
to such a suggestion? And do you think that should carry any weight? 

Mr. Gornick: I think so. 

Mr. Duiker: My answer is no. I don't know how you can define it. 

Mr. George: It means exempting big corporations — that's the way 
it's going to be construed. There are going to be some resounding 
speeches on the floor of Congress. 

Mr. Vickrey: I think it's irrelevant. It's not close corporations but 
corporations predominantly owned by stockholders in high income tax 


Mr. Gornick: Defining the amount of control that — 

Mr. George: Well, to relatively closely controlled corporations? 

Mr. Vickrey: No, it's not a matter of the closeness of control; it's 

a matter of the tax bracket of the dominating stockholders. 

Mr. Gornick: When do stockholders become dominating? 

Mr. Vickrey: Fifty-one per cent ownership. There may be a group 

_ „ , of one hundred stockholders who together own 

Tax Brackets _. D _ 

r ' . . 50 per cent. The corporation may not be closely 

of Dominating £ /, r _ . . ' , 7 

. , , , , held by any ordinary definition, but if all those 

Stockholders , -, -, 1 , , , ■ , , . , . 

one hundred stockholders are in the high income 

tax bracket, that is a 102 case. 

Mr. Austin: Yes, it isn't held evenly — maybe just a half per cent 

Mr. Vickrey: I think it's necessary to specify the income tax 
bracket of those who are effectively influencing dividend policy, 
whether they're a large number or a small number. 

Mr. Duiker: I think legislatively it would be a very, very diffi- 
cult thing to draft such a program in the law. I don't think it would 
be very helpful. 

Mr. George: I think it would be very unlikely to be drafted, and 
I'm not sure that I would agree if it were. 

Mr. Gainsbrugh: You're now beginning to see, however, how little 
clarity you're going to get, because this is one of the major areas in 
which clarity is desired. 

Mr. Gornick: How can you clarify the doubts that have been 
engendered by the Trico case? 

Mr. Duiker: Well, why do you need it, anyhow? Because it's usu- 
ally a pretty good defense if you haven't got anybody in there who's 
benefiting, and I don't think the Treasury is going to go after that 
kind of corporation anyhow, so what good is it going to do you in 
the long run? Because you're either in the bracket or you're not in 
the bracket, and you've got an awfully good defense. 

Mr. Austin: I made some such comment this morning. 

Mr. George: Should it read: Should 102 be made applicable only 
to corporations controlled by high-bracket stockholders? 

Mr. Vickrey: No, because they might not have any substantial 
equity in the profits. 

Mr. Gornick: Mr. Connolly suggested it should be made applicable 
only to personal service corporations. This reads, "only to those not 
mainly engaged in operating business." Now, his theory was that com- 


panies actively operating a business should not be subject to 102. I 
think that the fact-finding panel thought that unreasonable accumu- 
lations are found principally in close corporations whose income is 
not derived from manufacturing operations. 

Mr. George: I don't recall that any decision was required of the 
fact-finding panel. They were simply raising the question. 

Mr. Gornick: Yes. 

Mr. Vickrey: Well, again, that is one that gave rise to the query: 
In your pseudo-operating business, is there any justification for heavy 

Mr. George: I think it is an impossible exemption, myself. 

Mr. Austin: I don't think you've got much left, if you do that. 

Mr. George: Well, how about the reservation that Mr. Vickrey has 
been suggesting? Where it was controlled by stockholders? High-income 
stockholders? Then you replied they may not be subject to surtaxes. I 
didn't understand that. 

Unidentified Speaker: Fifty-one per cent control. 

Mr. Vickrey: No, I mean if they hold 10 per cent and control the 
dividend policy, and control it in their own interest. Then you still 
have a Section 102 case, in spite of the fact that it may be to the 
detriment of a substantial group of low income stockholders, who may 
even own the majority of the stock in small blocks. 

Mr. Richardson: I suppose the answer to this one is that it would 
be desirable, but probably not politically feasible. 

Mr. George: Then I ask: Do you want to bother about it? 

Mr. Vickrey: No, I think probably you can't. 

Mr. Duiker: That's what I would say. I don't think you're going 
to get anywhere. 


Mr. George: Should an accumulation of 30 per cent in any one 
year be exempt? With alternatives— 10 per cent, 20 per cent, 30 per 

Mr. Vickrey: I would suggest that that be averaged over several 
years, some way. 

Mr. George: There is an averaging question later on. We could 
combine them — there's nothing to stop us from combining them. 

Mr. Vickrey: The question is, though, as to the desirability of any 
such exemption. 

Mr. George: That's right. There is a question of principle here. 


Mr. Duiker: Well, I'm all in favor of flat exemptions — averaged. 
Some corporations should and do distribute 100 per cent. 

Mr. Vickrey: They had such a thing in the personal holding com- 
pany tax, but without this — quite a long while ago. 

Mr. Duiker: I think it's completely inequitable. 

Unidentified Speaker: I don't like such flat — 

Mr. Vickrey: Well, in terms of equity, it's equitable in this sense. 
Take two investors; one of them invests in a holding company and the 
other invests in an operating company, and they both accumulate 
30 per cent. Now, the two people are being treated alike as investors. 
From the company point of view, in one case there's a business reason 
and in the other case no business reason for the accumulation. Now, it 
seems to me that as a matter of equitable treatment between the two, 
they both ought to be able to accumulate 30 per cent. 

Mr. George: I don't see the same problem with respect to equity — 
with respect to a holding company as compared with an operating 

Mr. Vickrey: Yes, if you like to discriminate against holding com- 
panies. I would rather discriminate — 

Mr. George: Discriminating with respect to this particular pur- 

Mr. Vickrey: Yes. 

Mr. Duiker: Of course, the tax already does discriminate with re- 
spect to holding companies. 

Mr. Richardson: Well, a holding company may or may not be a 
complete holding company. You may have enough operations to take 
you out of the statutory definition of holding company. 

Unidentified Speaker: But you can see what would happen to a 
flat 30 per cent, or any per cent, limitation if you have a closely held 
company with the stockholders in the high brackets. Automatically 
they are relieved of the liability for the 30 per cent whether they have 
any use of the money or not. 

Mr. Vickrey: Yes, but I see no reason why, if you relieve one per- 
son, you shouldn't relieve everybody. 

Mr. George: Well, I suppose that gets back to your bias against 
having the purposes of the retention carry any weight in determining 
the distribution. 

Mr. Vickrey: Exactly. 

Mr. Duiker: Aren't we getting away from the basic purposes of 
Section 102? 


Mr. Vickrey: Well, what is the basic purpose of Section 102? Is it 
to control management — 

Mr. Duiker: No, no. 

Mr. Vickrey: — or to secure equity among the individuals? 

Mr. Duiker: No, it isn't that. No, the basic purpose of Section 102, 
as it was put in the 1913 act — and has always been there — is to see 
that individuals do not use a corporation for the purpose of accumu- 
lating surplus to avoid tax on shareholders. 

Mr. George: Why only taxes to be avoided? 

Mr. Duiker: Because they think that there ought to be a distribu- 
tion and a tax on individual shareholders where there is an unreason- 
able or an unneeded amount of money in a corporation. When a 
corporation is used as a device or is created for the purpose of avoid- 
ing taxes, then there is a penalty. 

Mr. George: The purpose of my question was to find out what 
relative weight you attached to revenue and equity. 

Unidentified Speaker: Well, I think the problem can be stated in 
the inversion: That it seems to be basic policy to permit corporations 
to retain earnings without further tax, so long as it's justified by busi- 
ness requirements. 

Unidentified Speaker: That's right. 

Mr. Vickrey: It's all right if you avoid tax through absent-minded- 
ness, but it's terrible if you do it on purpose. 

Unidentified Speaker: I don't think that type of thing is an argu- 
ment for deferrence. 

Mr. George: Absent-mindedness? 

Unidentified Speaker: Complete lack of thought which is some- 
what equivalent to that. 

Unidentified Speaker: Well, at any rate, it's a denial of intent. 

Unidentified Speaker: That's right. 

Mr. George: It could be argued that way. What about it? Does 
anybody want a percentage exemption? 

Mr. Vickrey: Yes. (Laughter) 

Mr. George: How about the rest of you? 

Mr. Duiker: Not me. 

Mr. George: Mr. Duiker says no. Mr. Richardson? 

Mr. Richardson: I would much prefer a dollar exemption. 

Mr. George: Anything, Martin? 

Mr. Gainsbrugh: Well, I'm in favor of delimitation, so far as 
we can, so that the major body of American business can say, "I 


know now that Section 102 does or does not affect me," but I don't 
think this is the way to achieve it. I'm against a flat exemption. 

Mr. George: As far as I'm concerned, unless there's a cry of pro- 
test, it's out. 


Mr. George: Should use of 5 1 per cent of the accumulation within 
three years relieve the taxpayer from challenge? 

Mr. Austin: I think it should. 

Mr. Richardson: Except that you're getting up into more blue 

Mr. Austin: No, this is something else. This isn't distribution. 
This is use of the money. 

Mr. George: How would that operate? 

Unidentified Speaker: Are you using that, or are you using subse- 
quent earnings, or what are you doing? 

Unidentified Speaker: Theoretically I agree with that, but prac- 
tically I don't see how you could do it. 

Mr. Duiker: I don't either — what are you going to say about the 
use of the money? 

Mr. George: That means you're going to have to wait three years 
before there's any action. 

Mr. Duiker: That's right. 

Mr. Richardson: Yes, and then you'd have to prove that it wasn't 
the accumulation in the interim that you were using, but the accu- 
mulation of the past. 

Mr. George: In other words, it's open end, goes on interminably. 

Mr. Richardson: The continuing, prosperous company would have 
a terrible time. 

Mr. George: Shall we call it nonadministrable? 

Unidentified Speaker: There's probably not a break-off point. 

Mr. George: Nonadministrable. 


Mr. George: Should an exemption of $100,000 of earnings be al- 
lowed in assessing of 102 penalty? 

Mr. Vickrey: It's too big, but otherwise I agree. 

Unidentified Speaker: Of course, there again, how about a re- 
duced penalty? 

Mr. George: That comes later. 

Unidentified Speaker: I'm inclined to agree very much with the 


suggestion, but I wonder whether we're not then advocating the same 
thing that we both deplored before — the artificiality of decision. Be- 
cause if $32,000 is as much as your corporation gets as earnings, it's 
going to try to increase some expense $2,000 to get out under the 
$30,000, or something else. 

Unidentified Speaker: Well, the $2,000 could be an exclusion as 
well as an expense. 

Mr. Gornick: Suppose you have an exemption of $100,000. Would 
you have this case, then: Somebody would come along and invest 
$1,000 in an oil well, and make $100,000 the first year. Now, he'd be 
exempt, wouldn't he, from Section 102 if he didn't pay any part of 
it out, just accumulated it? Is that what you want? Do you think Con- 
gress and the Treasury would feel that that would be desirable? 

Mr. Vickrey: What they do now is only tax it at 271^ per cent. 

Mr. Gornick: Well, that's right, but they do tax it. 

Unidentified Speaker: Subject to the various conditions. 

Mr. Gornick: Yes. 

Unidentified Speaker: Providing the man doesn't have any par- 
ticular business needs, he'll keep it out entirely, regardless of any 
purpose or business needs. 

Mr. George: I have some sympathy, myself, with a flat exemption 
of a smaller order than this for the small business, merely to relieve 
worry and the necessity of trumping up a case that you can't clearly 
anticipate. In other words, I would just resolve that in favor of a small 

Mr. Gornick: All right. Example number two: An insurance 
broker. He didn't invest anything. He made $25,000 this year, or 
$100,000. He makes $100,000 next year. In ten years, he makes a mil- 
lion dollars. No part of it would be subject to 102 under such a 

Mr. Vickrey: I think probably a modest exemption, except for 
personal service corporations would be desirable. 

Unidentified Speaker: — insurance basis or anything else is going 
to engage in that activity, and let the money stay in the corporation, 
just to avoid the tax? 

Mr. Gornick: Oh, he might invest it in something. 

Unidentified Speaker: — just how long does he last? 

Mr. Gornick: Well, suppose I'm an insurance broker and I made 
$100,000 this year. The $100,000 of earnings, if I took them out of 
the corporation, would be taxed about $60,000 or $70,000. 1 would say, 
"Well, here — I've got a $100,000 exemption so I'm going to leave that 


right in there." Rather than that, I'll just invest in an apartment 

Mr. George: What point are you trying to make? That the amount 
is too large, or that you don't like the principle? 

Mr. Gornick: It's the principle that seems to me difficult to sup- 

Mr. George: Supposing it were $25,000? 

Mr. Gornick: I don't think that would make any difference. 

Mr. Duiker: Theoretically it's not supportable, if you understand 
the purpose of the law. 

Mr. Vickrey: This particular example would suggest that you need 
to put the exemption on a cumulative rather than an annual basis. 

Mr. Duiker: That's right. 

Unidentified Speaker: That's the same principle we have in the 
excess profits tax. 

Unidentified Speaker: Well, can't you really write the exemption 
so that it will apply where there are multiple corporations? 

Mr. Gornick: I think this proposal would be subject to the criti- 
cism that if you did this, then you really are not looking out for any 
fair technique from the standpoint of the Treasury. 


Mr. George: Well, you folks have got to be a lot more enthusi- 
astic than this to get me to retain any of these provisions. I'm going to 
assume you don't want it in there. 

Should the penalty rate be reduced by half? 

Unidentified Speaker: Among all of the things that have been dis- 
cussed which have been based on artificially drawn lines, that presently 
drawn line is the most unsound one that could be drawn because 
you're drawing it on the basis of the earnings of the corporation and 
not upon the tax status of the individual, which is the worst possible 
place to draw it for a difference in rate. Why should a corporation 
earning and retaining $90,000 be taxed at 271/2 P er cent, when all of 
that would go to one stockholder; and one earning $250,000 and re- 
taining all of it, gets taxed at 381^ per cent, when it would go to 
twenty stockholders? 

Mr. Vickrey: Well, there's no way of doing it, I suppose. But I 
should think that there is some graduation on the average, which 
would be better than none. 

Mr. Duiker: That's why my suggestion was that in respect to cor- 


porations which had earnings of less than $100,000 they should be 
exempted. That was one of the suggestions I had here. 

Mr. Austin: A lower rate scale — 

Mr. Duiker: Lower rate scale for corporations with, say, earnings 
of $25,000 and $50,000. 

Unidentified Speaker: That could probably be worked out. 

Mr. Vickrey: Well, with a graduated scale, you don't need a top. 

Unidentified Speaker: No, but here the basis of graduation differs 
from the undistributed earnings to which the tax is applied. 

Mr. George: Is your rate going to depend on the entire earnings 
or just the undistributed earnings? 

Mr. Vickrey: I assume the undistributed earnings. 

Mr. Duiker: No, it would apply on the undistributed 102 net. 

Unidentified Speaker: Yes, but is the rate determined by the size 
of the undistributed 102 earnings — or is it determined by the net 

Mr. Gornick: — 102 net income which is earnings less taxes less 

Mr. Duiker: And the corporation's earnings less $25,000. The rate 
is reduced to 271/2 P er cent. 

Unidentified Speaker: Well, the undistributed earnings — O.K. 
that's a different thing. That means a graduated schedule. 

Mr. Duiker: That does it. That meets your problem a little bit. 
There still is a tax, but it's a lesser amount on the corporations that 
have a smaller amount of earnings. 

Unidentified Speaker: I am more inclined to go along with re- 
duction of the percentage rate on a sliding scale than I was with ex- 
emption of percentage of accumulation within three years. 

Mr. Gornick: Well, what would be the top of the sliding scale? 
Not in excess of the present rate. 

Unidentified Speaker: Twenty-seven and a half per cent to 381^ 
per cent. 

Mr. George: I don't know what criterion to suggest for the rate. 
Everything that we argue would be involved in trying to change the 


Mr. George: Should the penalty under Section 102 be applied only 
to the unreasonable part of the accumulation? In that case, should 
the rate of penalty be increased? 


Unidentified Speaker: Yes, because you're going to get a different 

Unidentified Speakers: Yes. 

Mr. Duiker: It's desirable, but you'll never get it. Let's be prac- 

Mr. Austin: I don't know that it's even desirable. 

Mr. Vickrey: The objective, I think, is a desirable objective but 
it seems to me to promote litigation rather than the reverse. 

Unidentified Speaker: You not only have a problem as to the gen- 
eral state of mind, but you would also have the courts intervene in 
every case and be the board of directors for the corporation. 

Mr. George: I might explain that when I first drafted that ques- 
tion, I classified it under the last heading of "judicial." The reason I 
did that was because of a strong feeling in the fact-finding panel that 
were such a rule as this to be introduced, it would stiffen the attitude 
of the Tax Court and the other courts in deciding on the merits of 
the cases, and not in determining guilt. They know now that the 
penalty is to be applied to all of the undistributed — 

Mr. Austin: There's something in that. They could give an adverse 
decision and mitigate its effect. 

Mr. George: Yes, so that they would be inclined to take the size 
of the penalty into consideration in borderline cases, in the process 
of determining whether there's guilt. So I put it under judicial, as 
being more of a judicial choice than a substantive one — and then I 
took it out again, and put it under administrative. 

Mr. Gornick: You can argue with considerable force on either side 
of this thing. 

Mr. George: Yes, on the grounds that I mentioned. 

Mr. Gornick: That's right. And I don't know — it's a tough one, 
really, to answer with any degree of feeling that you're doing the wise 
thing, one way or the other. 

Unidentified Speaker: Well, how many 102 cases are now litigated? 

Mr. George: Relatively few. 

Unidentified Speaker: Very few. 

Mr. Austin: I think, as we said earlier — as we said in the fact- 
finding panel — the problem is not so much one of how many are liti- 
gated as the fear of the vastly greater number which will never get 
to litigation. 

Mr. Gornick: Well, I think that this proposal would do this: It 
would tend to minimize the use by agents of the 102 club, because 


they'd have to take the second step and, say, determine how much was 

Unidentified Speaker: Ninety-nine per cent. 

Mr. Gornick: Well, you say 99 per cent, but obviously when it 
got to conference, and the technical staff got into it, it would, I think, 
help settle cases and eliminate the bludgeon aspect of it. It would be 
less likely to be taken to court, it would seem to me, don't you agree? 

Mr. Austin: I would think so. 

Mr. Vickrey: Well, I think what would happen would be that the 
taxpayers who now do not pay 102 surtax would have less fear of the 
lightning falling and the lightning wouldn't be so heavy, if it did 

Mr. Austin: That's right. 

Mr. George: The effect would be prolonged. 

Mr. Vickrey: — prolonged but, on the other hand, it seems to me 
that every case in which the Commissioner finally asserted a 102 de- 
ficiency would almost have to be taken to court to determine the 
amount of the deficiency. 

Mr. Gornick: Not necessarily, because now it is just simply, "Well, 
here is 102, and this is the tax." Period. And, "If you don't do this, 
why, then, we'll do this." Whereas, if he had to say, "Well, 102 applies, 
and this is how much it does apply to — " 

Mr. Austin: Well, it would effectually take the teeth out of the 
act, so far as Congress and the Treasury are concerned. 

Unidentified Speaker: Well, how many cases do you find of Sec- 
tion 102 tax being asserted where the agent says, "Now, look, you 
paid $60,000 in dividends. You have $120,000 in earnings. You should 
have paid $90,000"? 

That's not the way it works. The case arises in which they say, "You 
fellows don't need any of this." 

Mr. Austin: No, but the point is that they think they have a case 
that way. It amounts to saying that the split cases are the ones that 
get into controversy. When they feel that they've got a clear case, 
there's no need at all for this — 

Mr. George: How many cases would there be in which an agent 
decided that you didn't need this much, in place of deciding "This is 
all that you need"? Or would be more likely to say, "You don't need 
any of this"? 

Mr. Duiker: Well, at the present time, he doesn't have to decide 
the degree of it at all. He just says, "You should have distributed 
more," and then you go to court and litigate it and — 


Mr. Austin: Can you think of any case in which a court has said 
they retained, let's say, so much and should have retained only so 

Mr. Duiker: That's right. You're liable to get stuck for the whole 

Mr. Gornick: I think they say that certainly some part of it might 
have been justified but not — 

Mr. Duiker: They're not allowed to make any finding as to the 

Mr. Gornick: That's right. But now they would be. In other 
words, if they find that any part of the accumulation is unreasonable, 
they can stick you for the whole. And the courts do in their state- 
ment — they say, "We're not going to speculate about how much of 

Mr. George: Well, how often would it be that in their own minds, 
by the kind of test that they apply, they're likely to decide that you 
need some of it but not all of it? Wouldn't a great majority of cases 
be those in which they said, "You don't need to retain what you have 

Mr. Duiker: On the contrary, I think if you take as example the 
valuation of closely held stock or compensation, the Commissioner 
usually sets his sights quite high — higher than they ought to be; the 
taxpayer sets them low, and the Tax Court usually comes right in 
the middle. That's the way I would think 50 per cent of your valua- 
tion cases go. 

Mr. Gornick: It would seem to me that there is hardly any oper- 
ating company that doesn't need accumulation. It's never 100 per 
cent dividends. An operating company just isn't a good business com- 
pany if it pays out all its earnings in the first place; simply to take up 
depreciation it would have to have a fund to meet depreciation re- 
quirements. Otherwise — 

Mr. Austin: There are quite a number of companies that have 
built up so much in the past that they have no problem of deprecia- 

Mr. Gornick: Well, take the depreciation case. Any operating 
company will have to replace its physical assets sooner or later. But if 
it declares out every bit of its earnings, it's in effect declaring a 
liquidating dividend. 

Mr. George: Oh, you mean extra reserve to take care of depre- 


Mr. Gornick: I think almost any corporation would justify some 

Mr. George: What do you want to do with this question? 

Mr. Gornick: I'd answer yes, assuming it would be applied only 
to the unreasonable part of the accumulation. 

Mr. Austin: I'd go along with that. 

Mr. George: How about you, Mr. Duiker? 

Mr. Duiker: I don't like it. 

Mr. George: Mr. Richardson? 

Mr. Richardson: I'm strongly in favor of it, although I admit it 
presents difficulties. 

Mr. George: Martin? 

Mr. Gainsbrugh: I'm neutral on it. I'm particularly impressed by 
the argument that if this were adopted it would pull the teeth out of 
Section 102. 

Mr. Richardson: If I were convinced of that, I would be even 
more strongly in favor of it. (Laughter) 

Mr. George: Do you care to correct the record? (Laughter) Mr. 

Mr. Sonderman: Well, I think the suggestion is very good, but 
how are you going to determine the unreasonable portion? I'm trying 
to think about my own company, and I don't know how to deter- 
mine it. 

Mr. George: Mr. Vickrey, what's your opinion? 

Mr. Vickrey: Well, I don't know. I think you could increase the 
rate to give it a little more effect, and I might be willing to go along. 
I don't think I would want to accept this without an increase in rate. 

Mr. Gornick: Well, you've got three in favor. 

Mr. George: Well, I've already marked that question "No." 

Mr. Sonderman: Is that decisive? 

Mr. George: Yes, I guess so. A moderate no. (Laughter) 

Unidentified Speaker: Well, I don't know. I would guess that 
Connolly would vote yes. (Laughter) 

Mr. George: Will you read the next question. 

2. Evidence 


(1) Immediacy 
Mr. Austin: The next question is the immediacy issue. 
Should business be allowed to accumulate against a period of de- 


pression, particularly if its records show substantial use of its earnings 
over time for maintenance of employment, stabilization of dividends 
to offset fluctuating sales increment, etc., and over how much time? 

I think perhaps we could deal with this better if we made the ques- 
tion more general. Are we in favor of legislative amendments which 
would require consideration of business needs, not immediate, as the 
courts have held? In other words, should the law spell out the require- 
ment that cognizance be taken of future needs as well as immediate 
needs under the terms of the section? 

Mr. Richardson: I'm very much in favor of that. 

Unidentified Speaker: Wouldn't it be easier, Maurice, to ask any- 
one who does not agree to express an opinion? I think it might. 

Mr. Austin: As I recall it, the only dissenting voice is Mr. Vickrey's 
— his feeling that he'd like to change — 

Mr. Vickrey: I would like it so circumscribed that it would apply 
only to needs in terms of a moderate or normal rate of growth, not to 
branching out or sudden expansion, except for small firms that would 
probably be covered by an exemption. 

Mr. George: Well, if this amounts to a complete carte blanche to 
plan for almost anything, this amounts to a repeal of Section 102. 

Mr. Vickrey: Well, a statement of reasonable needs, present or 
future, still requires demonstration on the taxpayer's part of those 
needs. You've got to convince the court that it's true. 

Mr. Austin: It doesn't remove the present requirement that, 
whether true or not, it's got to be now, not five years from now. 

Mr. Gornick: Yes, in other words, if they're reasonable business 
needs, there's no requirement that the company has to spend them this 
year rather than two years or five years hence. 

Mr. Vickrey: Well, I'm in favor of this. I do raise the question of 
whether this, without any other strengthening provisions, does not 
make 102 substantially a thing that is invoked only when the taxpayer 
takes off his surtaxes conspicuously. 

Mr. Austin: In other words, you favor the principle with a caveat 
that the taxpayer shouldn't be put in a position where you have to 
take his word for anything he says. 

Mr. Vickrey: No, it's not quite that, either. I am in favor of this 
because I think that without it the situation is intolerable. 

Mr. Richardson: I think that's right. 

Mr. Vickrey: The situation where there is an immediacy require- 
ment leads to immediate outlay. The question whether, with this 
looser interpretation, we have anything left at all — 


Mr. Richardson: I think it's too open. 

Mr. Vickrey: But I would rather have nothing at all than to 
have a provision that stimulates waste. 

Mr. Richardson: Well, we have a great deal of fact-finding to the 
conclusion that there has been a good result from the section in its ap- 
plication over a period of years. Maybe too good, maybe too exten- 
sive, but it has accomplished some of its purpose. That has been 
accomplished without this immediacy factor which is of rather recent 

Mr. George: Would you still feel the same — would you leave this 
clause "against a period of depression" particularly? 

Mr. Austin: Well, wait a minute. You've restated the question. 

Mr. George: I might have known. (Laughter) 

Mr. Austin: "Foreseeable needs in the distance." 

Mr. George: Oh, you've gone back to that one? (Laughter) I was 
going to suggest that. 

Mr. Austin: I think we're all in favor of it. 

Mr. George: All right, what do I have to put down here? Have 
you shortened it? 

Mr. Austin: Yes. Say unanimously O.K. on the revised question. 

Mr. George: — for reasonably foreseeable needs. This is a judicial 
phrase, I assume. 

Unidentified Speaker: Well, we didn't use that phrase. I think 
they spoke in terms of "requiring cognizance be taken of future as 
well as immediate needs." 

Mr. Gornick: Yes. In other words, should the present immediacy 
principle enunciated by some courts be repealed? 

Mr. George: All right. 

(2) Longer Statute of Limitations 

Mr. George: Would a longer statute of limitations be warranted 
as a means of extending the period within which use of accumulations 
could be shown? 

Mr. Gainsbrugh: No. 

Mr. Austin: No. 

Mr. Gornick: No. 

Mr. George: I expected the answer to be a rather positive "No" 
anyway, because of all the other implications that would follow. 

Mr. Austin: That's right. 


(3) Averaging of Accumulations 

Mr. George: Would it be feasible to allow accumulations over 
time in determining your allowable proportion of earnings retained 
under Section 102, and over how long? 

Unidentified Speaker: Well, I'm not clear as to what the question 

Mr. Vickrey: Is this a mechanism for computation of the amount 
of tax? Or is this — 

Mr. George: My recollection is that there was envisaged the kind 
of situation where maybe you retained a little bit in one year and a 
whole lot in another year — it may be tied up with an immediacy 

Mr. Austin: Probably what they had in mind was: Should we 
establish a rule that Section 102 would not apply to any case where, 
over an average of five years, the corporation distributed at least 50 
per cent or 60 per cent of its earnings. 

Mr. George: Or 70 per cent — if that's a rule of thumb. 

Mr. Gornick: Yes. 

Mr. Vickrey: That goes back to that "rule of thumb" situation. 

Mr. Gornick: That's right. 

Mr. George: Well, I think there may be something like this in 
it. You come to a year in which you're not ready to use it for a num- 
ber of reasons. Maybe apart from being unforeseeable, they just don't 
know. And so they point to the fact that, "Look, we have been reason- 
able up to now. This year, we want to play safe. And our record shows 
good intention." 

Mr. Vickrey: Then you're going to make the back years a con- 
sideration in finding liability, rather than a mechanism for compu- 

Mr. George: Yes. That's right. It's evidence — not determining. 

Mr. Vickrey: Don't the courts do that now? 

Mr. Gornick: It's a little difficult to evaluate, in a way. Whatever 
percentage is established, there's a tendency that if there is any devia- 
tion from that percentage you are willy-nilly guilty. 

Mr. Vickrey: Well, I'm all in favor of that. 

Mr. Austin: Of course, I'm never sure, when you say things like 
that, whether you mean that you're in favor of them by themselves 
in the abstract, or in company with some other provisions that you 
would introduce. (Laughter) 

Mr. Vickrey: Let us say that I am in favor of a set level, inde- 
pendently of any other changes, I think. 


Mr. Gornick: Well, I suppose it certainly leads to clarity. That 
would be one side. You're over the line, or you aren't. 

Mr. Austin: That's part of that general question, isn't it, as to 
whether we should have an exemption for companies over a certain 
percentage of earnings, whether year by year or on an average basis. 

Mr. Gornick: It's related to that. 

Mr. George: Well, it simply adds weight to what Mr. Richardson 
said is already a consideration. 

Mr. Austin: By tying this to a specific exemption provision, or 
just as a general statute? 

Mr. George: It is a general rule in consideration of evidence. 

Mr. Austin: It might be regarded as superfluous, because I think 
to that extent it is taken into account. 

Unidentified Speaker: If you look at a company's dividend record 
over a number of years — they don't go year by year, pick out the bad 
ones and disregard the good ones. 

Mr. George: Well, you remember my specific case. They've had 
four or five years of heavy distributions and moderate retentions. This 
year, you see, they cannot show intention but they want to play it 
safe, on the grounds of general judgment about the future. 

Mr. Sonderman: That is especially true with companies in heavy 
industry. When you consider the earnings over a period of ten to 
twenty years, the cycles during that period can get very steep. 

Mr. Austin: Well, what you're saying in effect is that we ought 
to look at the record. 

Mr. Duiker: That's already reflected in surplus anyhow, isn't it? 
You determine the retention in the light of — 

Mr. Austin: There is a case now where they had a good dividend 
record, sometimes paying out more than their earnings. This year they 
paid out nothing. Well, all that really says is — 

Mr. George: What do you expect to be the result? 

Mr. Austin: Well, they expect a good result by not resting on that 
alone. The only point they're making is that a closer look at that 
dividend record now is one of the factors in the situation. And what 
you're saying here is that you're going to compel them to average this 
one year in with the others. 

Mr. Gornick: Well, I don't quite agree, Maurice. They're re- 
quired to look at that dividend record now. 

Mr. Richardson: I don't think they will in normal cases. It has 
been shown of importance that the corporation which has had a 


normal high dividend rate has not been formed for the proscribed 

Mr. Duiker: Suppose their surplus is large and they can't just — 

Mr. George: I say that in the year 1950 there will be a strong 
temptation for many companies to put aside. No intentions for the 

Mr. Gornick: I would, too. 

Mr. Sonderman: Sound business at the moment would seem to 
dictate that. 

Mr. George: I think it would be deplorable if they carried the 
impulse too far, yielded to it too completely. Because that's the stuff 
of which recessions are made. But, nevertheless, I'm talking here from 
the standpoint of a concern trying to save itself, and not from the 
standpoint of economic policy. 

Mr. Sonderman: You take in the first half of 1949 — there were 
quite a few dividend reductions because that slight recession was 
going on. I know I attended the U. S. Chamber meeting that time, 
and I never heard so much grief as to what business might suffer. 

Mr. George: I sometimes think that all businessmen ought to be 
isolated. (Laughter) 

Mr. Gornick: Of course, you know, I suppose, the sentiment would 
be reciprocated with respect to economists. (Laughter) 

Mr. George: My remark was addressed only to this business of 
forecasting. (Laughter) 

Well, what do we do? 

Mr. Gornick: There is no unanimity of opinion. 

Mr. George: Uncertainty. 


Mr. George: The next question: Should the right to invest be 
inviolable if the investment is related to the business of the taxpayer? 

Mr. Gornick: Well, isn't that the rule? Investment in a related 
business is certainly not one of the condemned purposes. 

Mr. Vickrey: I think that somebody here must have had something 
else in mind. 

Mr. Gornick: I think the fact-finding committee referred to com- 
panies that have been unrelated to your business. I think the example 
the fact-finding committee gave was a baby carriage company buying 
out a cement company. 

Unidentified Speaker: Well, that's different. 


Mr. Gornick: But there is nothing to prevent the baby carriage 
company, for example, from investing in a steel company. 

Unidentified Speaker: In a steel company that's manufacturing 
baby carriage frames. 

Mr. George: We could cite a wide variety of cases here. It says 
here: The right to reinvest shall be inviolate as related to the business 
of the taxpayer. Well, anyway, aren't you going to conclude, even if 
we did pursue the matter, that it's unnecessary? 

Mr. Gornick: Well, I would say that the answer to that is yes, 
that the panel felt that that's exactly what the law is today. 

Mr. George: Unnecessary. 

Mr. Gornick: If there's any doubt about it, then it ought to be 
clarified. (Laughter) 

Mr. George: Unnecessary. (Laughter) 

C. Burden of Proof 

Mr. George: Next: The burden of proof. Is it desirable that the 
policy panel should take any position on changing the burden of 
proof under Section 102? 

Unidentified Speaker: Had you better consider the second sug- 
gestion of dividing the burden of proof first and then go back to 
this if you have to? 

Mr. George: Well, the second suggestion is a special division of 
the burden, but I'm willing to do that. 

Mr. Gornick: If the question is left just as it is, my answer would 
be yes. 

Mr. Vickrey: Again, I am lukewarm; I will go along with it. 

Mr. Duiker: Well, I would too, although I approach all these 
things from their tax standpoint. I don't think that I would stand 
for any sort of a recommendation if I didn't think it had some kind 
of acceptance. 

Mr. Gornick: Well, it got through the House of Representatives 
in H. R. 6712. 

Mr. Duiker: In limited form. 

Mr. Gornick: Well, the question reads: Is it desirable for us to 
take any position on changing the burden of proof under Section 102? 
I think that in limited form or any other form, the answer would 
still be yes. 

Mr. George: May I record a limited yes, and then go on. Martin? 

Mr. Gainsbrugh: Yes. 


Mr. Duiker: I would certainly be in favor of it if you eliminated 
that phrase "by the clear preponderance of the evidence." 

Mr. George: How many would eliminate the phrase "clear pre- 
ponderance of evidence"? 

Mr. Duiker: In any event you should eliminate that, even though 
you didn't do anything about changing the burden of proof. I should 
think that ought to be eliminated. 

Mr. George: How much change do you think that would make in 

Mr. Austin: I don't think any of this makes much change in prac- 
tice. It's a matter of whether it produces a different psychological 
atmosphere in the whole bill. 

Mr. Duiker: You see, now the burden is not only on the taxpayer, 
but it is by a "clear preponderance of the evidence." 

Mr. George: All right, I'm assuming assent on that. Any objection? 
In any event, eliminate "clear preponderance of evidence." 

Two principal objectives of the American Bar Association: First, to 
impose a penalty tax on the whole undistributed Section 102 net 
income where the Commissioner is able to carry the burden of proof. 
Second, in borderline cases, to impose a tax on only the portion of 
Section 102 net income which is unreasonably accumulated, placing 
the burden on — we passed on that before, didn't we? 

Unidentified Speaker: Yes, we did. 

Mr. George: — placing the burden of proof on the taxpayer but 
giving him the opportunity to make a distribution and abate sub- 
stantially all of the tax. That would be adequate. 

Mr. Gornick: Yes. 

Mr. George: Under the first proposal, the penalty would be 50 
per cent of the whole undistributed Section 102 net income (I under- 
stand that that is the customary broad penalty ratio) but someone 
objected that it normally applied only to the size of the tax, the 
amount of the tax, and not to the income involved. 

Mr. Gornick: I'd leave the present rates in effect, 271/2 per cent 
and 38^4 per cent, but not go along with 50 per cent. 

Mr. George: Well, there is a purpose, as I see it, in these rates — 
that requires a consideration of the purpose before there is a decision 
on the rate. 

Mr. Austin: Well, you can't take this piecemeal, anyway. It's a 
whole unitary proposal. 

Mr. George: Yes, that's right. Fifty per cent of the whole undis- 
tributed Section 102 net income where the Commissioner carries the 


burden of proof. And my reaction was that as long as we were putting 
the entire burden of proof on the Commissioner, and he did sustain 
that burden, it was proper to charge a higher penalty. In a borderline 
case — 

Mr. Gornick: I don't agree with that. 

Mr. George: All right, let me get back to it, then. In the border- 
line cases, the taxpayer would carry the burden (a) of establishing that 
the accumulations did not exceed the reasonably foreseeable needs of 
his business, and (b) of proving that the amount of the undistributed 
Section 102 net income corresponded to those needs. The penalty 
would be 77 per cent of the accumulation in excess of those needs, 
but a credit of 90 per cent against the amount of the deficiency (estab- 
lished in one of several ways) would be allowed if the taxpayer dis- 
tributed the amount upon which the determined tax was based (less 
subsequent dividend distributions in excess of Section 102 net income) 
within ninety days of the filing of notice. 

Do you want to take it up piecemeal or as to the general purport? 

D. Deficiency Dividend Credit 

Unidentified Speaker: Can we take up the retroactive dividend fea- 
ture first? 

Unidentified Speaker: We covered that under timing. 

Mr. George: Oh, no — no, that was only two and a half months, 
wasn't it? 

Mr. Gornick: That's right. 

Mr. George: I regard this as a different issue. The other was that 
after determination of profits, you would readjust your dividends. 

Mr. Gornick: Didn't we somewhere say something about 90 per 

Mr. Austin: No, we spoke about minority stockholders. 

Mr. Gornick: I think we could vote on that. I would say yes on 
that one. 

Mr. Vickrey: I vote in favor of a deficiency dividend credit. 

Mr. George: Separately — if it can be pulled out? 

Mr. Vickrey: Yes. 

Mr. George: Mr. Duiker? 

Mr. Duiker: Yes. 

Mr. George: It's your provision, but I thought you might have 
had a change of heart. (Laughter) 

Mr. Richardson: Yes. 


Mr. George: Mr. Richardson — yes. Martin? 

Mr. Gainsbrugh: Yes. 

Mr. Sonderman and Mr. Austin: Yes. 

Mr. Vickrey: Oh, boy! 

Mr. George: What do you know about that? Lucky I have no vote. 

Mr. Austin: That just proves it's not important. (Laughter) 

Mr. George: Yes, I suppose that's right. 

Well, then, we're going to say that what you've approved is a 
credit of 90 per cent. 

Mr. Austin: Well, I don't think the percentage enters into the 

Mr. George: Well, it did as read. It did unless someone changes it. 

Mr. Vickrey: Well, did we vote on the 90 per cent, or just on the 
general principle? 

Mr. Gornick: Just on the general principle. 

Mr. George: I submit that you voted on the 90 per cent. That's 
what I asked you to vote on. But, of course, that has nothing to do 
with what you want to do now. 

Mr. Gornick: There is a question whether it should be 90 per cent 
or 100 per cent. 

Mr. Vickrey: Well, I'd go along with 90 per cent if I thought it 
could be done. 

Mr. Gornick: Under the personal holding company provisions, it's 
100 per cent. Why should this be any more drastic than that? 

Mr. George: May I make a naive point here? It has been my 
thought that this is not separable from the rest of the proposal, that 
the only reason this provision was suggested, is because in a prior pro- 
vision the Commissioner had a right to assess a larger penalty if he 
was willing to assume the burden of proof. 

Mr. Vickrey: Well, whatever you assume, it is a separate proposi- 
tion, and you got a 100 per cent vote. 

Mr. George: I have that. (Laughter) But I can exercise the privi- 
lege of asking you what you mean by it, and what it implies. Because if 
this merely stood alone, then would there be any bar to any company 
taking any course because of a certain knowledge that in case of a 
finding against it, it could escape by paying out the dividend at a 
later date? 

Mr. Gornick: Pay the back interest. 

Mr. George: Is that enough of a consideration? 

Mr. Gornick: Well, it certainly is on personal holding companies. 


Mr. Duiker: Well, it is an emasculation of Section 102, in my 

Unidentified Speaker: I think so, too. 

Mr. George: I have difficulty in seeing the rationale of it by itself, 
in spite of the fact that that is what was approved. 

Mr. Vickrey: Well, you have, of course, 90 per cent as a penalty 
for taking a chance. 

Mr. George: Ten per cent penalty? 

Mr. Vickrey: Well, you have credit of only 90 per cent here, 
against the deficiency. 

Mr. Gornick: That's right. 

Mr. Vickrey: So that the remaining 10 per cent is the penalty. 

Mr. George: By the way, what happens to the interest under this? 

Mr. Vickrey: I assume that the interest is assessable. 

Mr. Gornick: The interest is assessable. 

Mr. George: Just as a matter of curiosity, how many of you feel 
that this would largely emasculate 102? 

Mr. Vickrey: On 90 per cent, I would say so. 

Mr. George: Ninety per cent credit in case you pay out after con- 
viction. That sounds passing strange to me — I don't know. 

Mr. Vickrey: Well, after all, bear in mind that these companies 
can safely feel that they would get by in the first place if they paid out 
60 per cent or 70 per cent. Here they get by only by paying out the 
whole. It does make a difference. 

Mr. Gornick: If they did it all in one year, and you pay the in- 
terest on it — 

Mr. George: Which is what? Over what period of time? 

Mr. Gornick: Probably over a five-year period — 

Mr. Austin: — until the time it catches up. 

Mr. Gornick: Closer to five or six, if it goes to litigation— maybe 
30 per cent. In the Trico case — 

Mr. George: Well, even so, it's a drastic reduction in the amount 
of the penalty that was intended by Congress. 

Mr. Richardson: What you're saying, then, is that the present pro- 
vision, which allows you a deduction and elimination of the 102 net 
income if you pay a current dividend — 

Unidentified Speaker: —you can avoid it by paying your current 
dividend, and here you avoid it by paying a subsequent dividend. If 
the intent is to get the dividend paid, you've accomplished it. 
Mr. George: I should think it would remove a large part of the 


hesitation on the part of any company as to whether to take a chance. 
In most cases they'll go ahead and retain and see what will happen. 

Mr. Duiker: Because: "I don't have to pay any tax anyhow, and if 
I get caught, I can distribute." 

Mr. George: Except for the 10 per cent and the interest clause. 

Mr. Vickrey: Under the present law, you see, they pay the penal- 
ties — 38 per cent, but they don't have to distribute. 

Mr. Austin: Yes, they do distribute. 

Mr. George: I'm sure it was the thought of Mr. Duiker's com- 
mittee that almost everyone would distribute. 

Mr. Austin: It doesn't necessarily follow. I can think of many cases 
where they wouldn't. They'd pay the 271/2 per cent. 

Mr. Vickrey: They pay the 38 per cent in a good many cases. 

Mr. Austin: That's right. 

Mr. Vickrey: And feel much better about it. 

Mr. Austin: That's right. 

Mr. Duiker: They do it cheaper in many cases. 

Unidentified Speaker: That's why I say I don't think it would 
necessarily be an emasculation. 

Mr. Vickrey: It will be an emasculation only in the cases of the 
companies that aren't really held by persons in high income tax 

Mr. George: Well, let's get back to the previous one. I admit I'm 
worried about this. I'm afraid of the reaction of the people to whom 
we're trying to give a very restrained analysis of the problem. 

The first was to impose a penalty tax — I don't have to read it again, 
do I? 

Mr. Austin: You're talking about what the Bar Association recom- 
mended, aren't you? 

Mr. George: Yes. 

Mr. Austin: I'm against it. I just don't like the whole setup and I 
think I made some remarks on it earlier. 

Mr. George: How much are we considering here? Do we have to 
go back to the first? 

Mr. Austin: The whole thing holds together. 

Mr. George: What you would be disapproving would be the divi- 
sion of the burden of proof? 

Mr. Vickrey: It seems to me that when you make a rather drastic 
difference in the tax, dependent upon a procedure that I gather is to 
be selected by the Commissioner, it creates an opportunity of gross 


Mr. Austin: It involves a problem of tactical choice, and I don't 
think tax liability should be made to depend on that. 

Mr. George: You mean as to which choice the Commissioner 

Mr. Austin: Or the wisdom of choice of a particular representative 
on what is purely a matter of tactics. 

Mr. Vickrey: That's what it's going to boil down to in each case. 

Mr. Austin: Which way they think they'll come out with the best 

Mr. Vickrey: It may be appropriate in paradise, but it's not quite 
possible yet. 

Mr. Austin: As we said this morning, I think in practice what will 
happen is that nine times out of ten the Commissioner is going to 
say, "Well, we determined what is a reasonable percentage for reten- 
tion. Go ahead, boys — the burden is on you." 

Mr. Gornick: Yes. 

Mr. Austin: Not only that, but a 77 per cent — 

Mr. Vickrey: I'd be in favor of the 77 per cent rate but otherwise 
not. (Laughter) 

Mr. Austin: I take exactly the opposite position. (Laughter) Funny 
how these things work out. (Laughter) 

Mr. George: Well, what all was approved before? The penalty 
would be 77 per cent of accumulation in excess of those needs, but a 
credit of 90 per cent — or is a credit of 90 per cent in any event all 
that is approved? 

Mr. Vickrey: Under the present law — (colloquy) 

Mr. George: I am bound by it. 

Mr. Gornick: That's passed. 

Mr. George: I am bound by it. I am disturbed by it, I freely admit, 
because I'm afraid that it will weaken the — 

Mr. Vickrey: The proposition passed but we can put it again. As I 
understood it, that was separated as a proposition to apply by itself. 

Mr. Gornick: Yes. 

Mr. Austin: If the law is otherwise unchanged. 

Unidentified Speaker: Beginning with a credit of 90 per cent. 

Unidentified Speaker: Yes. 

Mr. George: Yes, somebody asked me to do that, and I did it. And 
then, after it was done, I came to realize what it meant and I became 
uneasy. Because it doesn't seem to be as objective as most of the dis- 

Mr. Vickrey: Well, I am by no means conservative on this. But I 


don't see at all why, if a taxpayer is willing, on a question as uncer- 
tain as this whole Section 102 is, to make a distribution that is deter- 
mined as reasonable, why a penalty should not be drastically reduced. 

Mr. George: If the taxpayer is willing to make a subsequent dis- 
tribution after a finding against him? 

Mr. Vickrey: Yes. 

Mr. Austin: You're satisfied with it as it was passed, standing 

Mr. Vickrey: Anybody here changed his view on that? 

Mr. Duiker: I wasn't in favor of it. 

Mr. George: Well, the proposition is still the same. 

Have we disposed of everything that comes above that? In other 
words, this applies against every kind of case, borderline or any other 
kind. Is that clear? 

Unidentified Speaker: Yes. 

Mr. George: And you don't choose to distinguish between differ- 
ent types of burdens. 

Unidentified Speaker: No. 

Mr. Vickrey: If you're so concerned over it as to want to make it 
less than 90 per cent, that might be open, but I think that the 
opinion — 

Mr. George: I have no choice in the matter. I'm merely recording 
the vote. I expressed an opinion — and probably was out of order in 
doing that, and it was partly tactical and partly genuine. 

Mr. Vickrey: First time today you've crawled in on something. 

Mr. George: Well, I felt perhaps it was a privilege, calling atten- 
tion to something that might be damaging, without expressing an 
opinion on it. 

E. Presumption of Reasonable Accumulations 

Mr. George: Should the law be amended to create a presumption 
that in the case of operating companies, profit accumulations are 
reasonable unless the Treasury shall prove the contrary? 

Mr. Austin: That's another way of shifting the burden of proof. 

Mr. Gornick: I think I'd say that we don't have to pass on that. 

Mr. George: Well, I think it's covered really by the shift of the 
burden of proof. 

Mr. Gornick: I agree. 

Mr. George: I suppose this one that I'm about to read would be 


from another prominent business organization, and I think that they 
acted on it favorably. 

Amend Section 102 either (1) to place on the Commissioner of In- 
ternal Revenue the burden of proving that the corporation is im- 
properly availed of or (2) to limit the imposition of the penalty to 
corporate earnings in excess of some stated figure. 

Now, we have touched on both of those. We're been through them 
both. One prominent lawyer in the tax field thought that this would 
practically solve the problem of small business. 

I don't know as there's anything more. There isn't, unless it comes 
from the floor, or from the table. 

Mr. Duiker: Not from me. 

Unidentified Speaker: Nor from me. 

Mr. George: Well, I hope, Miss Walker, that this will be of some 
use to you. 

Mr. Duiker: My personal feeling is that if we get the lawmakers 
to consider the reasonable future needs of the business, we've accom- 
plished a lot. 

Mr. Austin: That's right. 

Mr. George: Got a question, Martin? 

Mr. Gainsbrugh: No, I don't want to shake the stability. (Laugh- 


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Seidman, J. S. "What to Do About Section 102," Taxes— The Tax Magazine, 
XXVIII (July, 1950), 678-82. 

Simon, A. Allen. "Corporate Surplus and Section 102 in the Postwar Period," 
Controller, XIV (December, 1946), 660-63. 

Economic Effects of Provision 

Ayers, Allan F., Jr. "Risk of Equity Masquerading as Funded Debt in Closely 
Held Corporations," Proceedings of New York University Seventh Annual Institute 
on Federal Taxation, 1948. Albany and New York: Matthew Bender & Company, 
Inc., 1949. Pp. 1120-43. 

Commerce Clearing House, Inc. "Improper Accumulations — Effect of Section 102 
Taxwise— Section 102 Surtax Not Paid," Corporation? Partnership? Sole Proprietor- 
ship? 1951 ed. Chicago, 1951. Pp. 13-15- 

Dorsey, Harold B. "Elements Surrounding Burden of Double Taxation on In- 
vestment Market," Exchange, IX (January, 1948), 1-2. 

Foulke, Roy A. "Expansion from Retained Earnings: Part 2," Dun's Review, 
XCIX (December, 1945), 14-22. 

Froehlich, Walter. "Role of Income Determination in Reinvestment and Invest- 
ment," American Economic Review, XXXVIII (March, 1948), 78-91. 

George, Edwin B., and Landry, Robert J. Shadow of "102" on Dividend Policies: 
With Emphasis on the Immediate Tax Problems of Small Corporations. Supplement 
to Dun's Review. New York: Dun & Bradstreet, Inc., 1947. 34 pp. 

. "Some Economic Issues of Section 102," Tax Review, VIII (June, 1947)' 

23-27. Reprinted in Accounting World, I (July-August, 1947)' 3 8 '47- 

Gray, Carl A. "Why Does Uncle Sam Pick on Us?" Saturday Evening Post, (Octo- 
ber 1, 1949). Condensed in Reader's Digest, LV (December, 1949), 130-34. 

Holland, H. Brian. "Tax Effects of Stockholder Loans to Corporations: Section 
102," Proceedings of New York University Ninth Annual Institute on Federal Tax- 
ation. Albany and New York: Matthew Bender & Company, Inc., 1951. Pp. 1101-2. 

Klein, Joseph J. "Section 102 — from Credit Grantor's Viewpoint," Bulletin of 
Robert Morris Associates, XXXI (March, 1949), 367-72. 

Nelson, Godfrey N. "Tax on Accumulated Surplus, Factor in Business Expan- 
sion," New York Times, (December 22, 1946). 

Platt, Joseph S. "Incorporation of a Sole Proprietorship," Proceedings of New 
York University Eighth Annual Institute on Federal Taxation, 1949. Albany and 
New York: Matthew Bender & Company, Inc., 1950. Pp. 105-16. 

Raum, Leonard. "Stock Purchase Agreements Among Stockholders of Close Cor- 
porations," Proceedings of New York University Eighth Annual Institute on Fed- 
eral Taxation, 1949. Albany and New York: Matthew Bender & Company, Inc., 
1950. Pp. 702-6. 


Schlesinger, M. R. " 'Thin' Incorporations: Income Tax Advantages and Pitfalls," 
Harvard Law Review, LXXI (November, 1947), 50-87. Digested in CCH Legal 
Periodical Digest, 6573-74. 

Directors' Liability as Result of Imposition of Penalty 

Columbia Law Review. "Derivative Actions Arising from Payment of Penalty 
Taxes Under Section 102," XLIX (1949), 394. 

Holzman, Robert S. "Management's Personal Liability for Section 102 Surtaxes," 
Proceedings of New York University Seventh Annual Institute on Federal Taxation, 
1948. Albany and New York: Matthew Bender & Company, Inc., 1949. Pp. 555-60. 

Lasser, J. K. "Tax Clinic: Derivative Actions Arising from Payment of Penalty 
Taxes Under Section 102," Journal of Accountancy, LXXXVIII (July, 1949), 80-81. 

, and Holzman, Robert S. "Personal Liability of Directors for Section 

102 Surtaxes," Controller, XVI (July, 1948), 342-44. 

Interrelationship with Other Taxes 

a. Capital Gains Tax 

Austin, Carroll. "Section 102 and Capital Gains," Taxes — The Tax Magazine, 
XXVI (April, 1948), 302-7. 

Butters, J. Keith, Lintner, John, and Cary, William L. "Income Tax — Capital 
Gains Tax — Section 102," Effects of Taxation on Corporate Mergers. Boston: Har- 
vard University Graduate School of Business Administration, 1951. Pp. 94-122. 

Seltzer, Lawrence H. "Tax Avoidance Through Capital Gains," The Nature and 
Tax Treatment of Capital Gains and Losses. New York: National Bureau of Eco- 
nomic Research, 1951. Pp. 227-33. 

b. Estate Tax 

Hilgedag, Raymond W. "Estate Planning in Income and Estate Building: Discus- 
sion of Section 102 Question," Proceedings of New York University Fourth Annual 
Institute on Federal Taxation, 1945. Albany and New York: Matthew Bender & 
Company, Inc., 1946. Pp. 49-55. 

Vandeveer, W. W. Statement Before Subcommittee on Study of Monopoly Power 
of House Committee of the Judiciary. Hearings. 81st Cong., 1st Sess. Washington: 
Government Printing Office, 1949. 

. "Suicide of a Business," American Affairs, XI (October, 1949), 228-32. 

Special Problems 

a. Depreciation 

Fitts, E. Grant. "Relation of Depreciation to Determination of Surplus and Earn- 
ings Available for Dividends," Virginia Law Review, XXXIII (September, 1947), 
581-610. Digested in CCH Legal Periodical Digest, 2545-46. 

b. Insurance 

Casey, William J. "Business Insurance," Trusts and Estates, LXXXIX (Decem- 
ber, 1950), 818-19. 

Clapp, Harrison B. "Keyman Insurance: Section 102 — Surtax," Proceedings of 
New York University Ninth Annual Institute on Federal Taxation. Albany and 
New York: Matthew Bender & Company, Inc., 1951. Pp. 35-37. 

Eichenbaum, E. Charles. "Corporate Insurance on Stockholders' Lives," Proceed- 
ings of New York University Eighth Annual Institute on Federal Taxation. Albany 
and New York: Matthew Bender & Company, Inc., 1950. Pp. 714-23. 

Hirst, Albert. Business Life Insurance and Other Topics. Bloomington [Ind.]: 
State Farm Life Insurance Company, 1949. 165 pp. 

Mannheimer, Albert. "Insurance to Fund Stock Retirement and Buy and Sell 
Agreements: Section 102," Proceedings of New York University Ninth Annual Insti- 


tute on Federal Taxation, i 95 o. Albany and New York: Matthew Bender & Com- 

Pa MiLLETT, Paul F P '"Key Man Life Insurance and Section 102," Journal of Amer- 
ican Society of Chartered Life Underwriters, I (September, 1947), 462. 

c. Personal Holding Companies 

Bouchard, George. "Section 102 and Personal Holding Companies," Major Tax 
Problems of 1948: Proceedings of University of Southern California School of Law 
Tax Institute, 1948. New York: Prentice- Hall, Inc., 1949. P. 212. 

Lang, John J. "Surtaxes on 'Personal Holding Companies and Corporations Im- 
properly Accumulating Surplus/ " The Tax Magazine, XIII (May, 1935), 274- 

Rolnik, Max. "Tax Problems of Importers and Exporters," Proceedings of New 
York University Eighth Annual Institute on Federal Taxation, 1949. Albany and 
New York: Matthew Bender & Company, Inc., 1950. Pp. 60-70. 

Rudick Harry T. "Section 102 and the Personal Holding Company Provisions of 
the Internal Revenue Code," Illinois Law Review, XXXIII (1938), 236; Yale Law 
Journal, XLIX (1939), 17 1 - 

Selected References on Taxation of Undistributed Profits 

Consideration of the Section 102 penalty tax on unreasonable accumulation of 
profits leads into the broader field of a tax on all undistributed profits. The litera- 
ture on this subject is voluminous. Selected references follow. 

Alvord, Ellsworth C. "The Taxation of Undistributed Profits from the Business 
Point of View," How Shall Business Be Taxed? New York: Tax Policy League, Inc. 
[now Tax Institute, Inc.], 1937. Pp. 90-112. . 

. "The Undistributed Profits Tax," Proceedings of the . . . National Tax 

Association, 1937. Columbia, 1938. Pp. 173-79- , , , „ , _. , „ 

. "The Undistributed Profits Tax and Stock Dividends and Stock Rights, 

Journal of Accountancy, (December, 1937), 414-22. 

Buehler, Alfred G. The Undistributed Profits Tax. New York: McGraw-Hill 
Book Company, Inc., 1937. 281 pp. 

Graham, B. "The Undistributed Profits Tax and the Investor, Yale Law Journal, 
XLVI (1936), 1-18. „,„■„, 

Grattan, C. Hartley. "Why Labor Wants Undistributed Profits Tax, Barron s, 
XXIX (April 18, 1949), 37-38. £ tt ^. .,,,',, „ 

Groves, Harold M. "Integration and the Treatment of Undistributed Profits, 
Postwar Taxation and Economic Progress. Committee for Economic Development 
Study. New York: McGraw-Hill Book Company, Inc., 1946. Pp. 40-73. 

Haas, George C. "The Taxation of Undistributed Profits from the Point of View 
of the Federal Tax Structure," How Shall Business Be Taxed? New York: Tax 
Policy League, Inc. [now Tax Institute, Inc.], 1937. Pp. 113-24- 

Hendricks, H. "The Surtax on Undistributed Profits of Corporations," Yale Law 
Journal, XLVI (1936), 19-51. 

Kendrick, M. Slade. The Undistributed Profits Tax. Washington: The Brookings 
Institution, 1937. 108 pp. 

. "The Undistributed Profits Tax of 1936 and Equity," Taxes— The Tax 

Magazine, XVII (April, 1939), 200-2. 

Kimmel, Lewis H. "Experience Under the Undistributed Profits Tax," National 
Industrial Conference Board Bulletin, XI (October 13, 1937), 105-15. 

Lent, George E. Impact of Undistributed Profits Tax, 1936-37- New York: Colum- 
bia University Press, 1948. 203 pp. 

Lutz, Harley L. "The Principle of the Undistributed Profits Tax," Bulletin of 
the National Tax Association, XXIII (April, 1938), 200-4. 

McCabe, Thomas B. "Improved Equity Markets: Removing Tax and Legal Im- 
pediments," Trusts and Estates, LXXXVIII ,(September, 1949), 534-36. 

McIntyre, Francis. "The Effect of the Undistributed Profits Tax Upon the 
Distribution of Corporate Earnings — A Statistical Appraisal," Econometrica, VII 
(July, 1939). 


Montgomery, R. H. "The Tax on Undistributed Income," Harvard Business Re- 
view, XV (1936), 19-28. 

National Tax Association. Committee on the Federal Corporate Net Income 
Tax. Harold M. Groves, Chairman. "Final Report," Proceedings of the . . . National 
Tax Association, 1950. Sacramento, 1951. Pp. 54-73. 

. "Preliminary Report," Proceedings of the . . . National Tax Association, 

1949. Sacramento, 1950. Pp. 437-57. [Comment on Section 102, pp. 456-57.] 

National Tax Association. Committee on Federal Taxation of Corporations. 
Robert Murray Haig, Chairman. "Report," Proceedings of the . . . National Tax 
Association, 1939. Columbia, 1940. Pp. 539-61. 

Nelson, Godfrey N. "The Taxation of Corporate Surplus," Proceedings of the 
. . . National Tax Association, 1936. Columbia, 1937. Pp. 221-33. Reprinted in The 
Tax Magazine, XV (January, 1937), 15-19. 

Schulman, Walter H. "Undistributed Profits Tax Avoidance After the Kosh- 
land Case," The Tax Magazine, XIV (December, 1936), 703-5. 

Seidman, Frank E. "Dividend Policy Under the Undistributed Profits Tax," Com- 
mercial and Financial Chronicle, CXLIII, 3213. 

Seligman, E. R. A. "Tax on Surplus Called a Danger," New York Times, (March 
22, 1936), 5 F - 

Shoup, Carl. "The Taxation of Undistributed Profits from the Theoretical Point 
of View," How Shall Business Be Taxed? New York: Tax Policy League, Inc. [now 
Tax Institute, Inc.], 1937. Pp. 125-34. 

Simons, Henry C. "Undistributed Corporate Earnings," Personal Income Taxa- 
tion. Chicago: University of Chicago Press, 1938. Pp. 185-204. 

Smith, James G. "Economic Significance of the Undistributed Profits Tax," Amer- 
ican Economic Review, XXVIII (June, 1938), 303-10. 

. "Reply [to Paul M. Van Arsdell]," American Economic Review, (De- 
cember, 1938), 740-41. 

Stein, Emanuel. "Revision of the Federal Corporate Income Tax: A Proposal," 
Tax Law Review, VI (January, 1951), 207-18. 

Straub, Walter A. Corporate Policy Trends Resulting from the Undistributed 
Earnings Tax. Financial Management Series No. 51. New York: American Manage- 
ment Association, 1937. 

Thorp, Willard L., and George, Edwin B. "An Appraisal of the Undistributed 
Profits Tax," Dun's Review, XLV (September, 1937), 5-36. 

United States. Congress, House, Committee on Ways and Means. Report on 
Revenue Bill of i 93 6. H. Rept. No. 2475. 74th Cong., 2d Sess. Washington: Gov- 
ernment Printing Office, 1936. 

Van Arsdell, Paul M. "Note on 'Economic Significance of the Undistributed 
Profits Tax' [by James G. Smith]," American Economic Review, (December, 1028) 
737-40. yd ' 

Vickrey, William. "Corporate Savings," Agenda for Progressive Taxation. New 
York: Ronald Press Company, 1947. Pp. 150-63. 

. "A Reasonable Undistributed Profits Tax," Taxes— The Tax Magazine, 

XXIII (February, 1945), 122-27. 

Wertheim, Maurice. "The Undistributed Profits Tax and What to Do About It," 
Harper's Magazine, (February, 1938). 


Absentee management, 55 
Abuse, prevention of, 238 
Accounts receivable: artificial increase in, 

86; increased, 49 
Accumulate, efforts to, 34 
Accumulation: because of fading market, 
161; extent of, 159, 231, 232; essential 
for investment, 236; for distantly fu- 
ture contingencies, 100, 106-7, 2 3°; f° r 
future expansion, 5; legitimate motives 
for, 85, 243; long range necessary for 
small business expansion, 128; need of, 
286; presumption of reasonable, 300; 
reasonable, 3; significance of over-all 
data on, 158; tax only on unreason- 
able, 136, 139, 174, 184, 199^ 205, 219, 
283-87; unreasonable, 201, 206, 283-87. 
See also Surplus, illusory 
Administration: assertion by agent harm- 
ful, 144, 152; attitude, 39, 44, 95, 169- 
70, 237; broad powers, 145; by courts, 
98, 118, 209, 259; centralized, 136, 177, 
228, 269; decentralized, 169; difficulty 
of, 231; fair, 13, 53, 144, 151, 241, 251; 
threat, 25, 88, 120, 135, 214, 235, 240, 
242; unfamiliar with business prob- 
lems, 144, 146, 211, 240; variations 
among agents and between Bureau 
and agents, 26, 73, 108, 121, 135, 151, 
169, 206, 208, 227, 241, 266, 273. See 
also Internal review and Regulations 

Advance planning, 89 

Advance rulings. See Rulings 

Advertising agency, 103 

Advice on Section 102, 129, 135, 141-42, 

American Bar Association, 192, 197, 198, 
202, 211, 217, 266, 272, 294, 298 

American Institute of Accountants Com- 
mittee on Federal Taxation, 216 

Anguish, 95 

Apathetic attitude towards increased 
costs, 21 

Application, limitation of, 275-87 

Apprehension. See Fear 

Argentina, 134 

Assets: conversion of, 18; nonbusiness, 
47; unwise acquisition of, 202 

Atkeson, T. C, 93 

Austin, Maurice, 9, 37-41, 255-57 

Australia, 71 

Auto dealers, 13 

Automobile company, 82 

Averaging accumulations, 68, 95, 171, 

207, 229, 260, 278, 290 
Avoidance of surtax, 61 
Ayers, Allan F., Jr., 3-6, 108-13 

/. E. Baker Company, 48 n. 

Ball bearings, 122 

Basis of control, 213, 216 

Belgium, 71 

Bentson, Mr., 144, 145, 274 

Binding contracts, 51 

Board of Tax Appeals, 48 n. 

Bonuses, 19, 21, 34, 85, 86 

Boston, 128 

Brazil, 134 

British profits tax, 70, 72, 137 

Buehler, Alfred G., 9, 28-29, 30 

Buffalo case, 118 

Burden of proof, 4, 64, 95, 122, 125, 132, 
171, 184, 192, 198, 199, 203, 204, 206, 
212, 217, 219, 220, 221, 237, 293-95, 
303; divided, 122, 125, 192, 198, 199, 
201, 203, 204, 205, 212, 219, 221, 237, 
294, 296, 298, 299, 301, 303; shifting 
of, 153' 255 

Bureau of National Affairs, 230 

Business activity, dampening effect on, 

Business cycle, 161, 229; accentuation of, 

165, 229; effect on 102 of, 129 
Business fluctuations, 22, 42, 45, 46, 51, 

161. See also Business cycle 
Business growth. See Expansion 
Business, new types of, 239, 241 
Business reasons irrelevant, 245 
Business records, 86, 95, 223 
Buyer's market, 15 

California, 21 

Canada, 62, 71 n. 

Canadian Tax Foundation, 72 n. 

Candy making, 83 

Cann, Norman D., 43-49 

Capital: access to market for, 225; addi- 
tions, credit for, 241; conservation of, 
70; depletion of, 58, 223; earnings ma- 
jor source of, 239; need, 53, 142, 159; 
reduced, 136; scarcity of, and divi- 
dend flow, 232; sources of, 19, 20, 224, 
239, 240; supply of, 46, 228, 232, 236, 




Capital expenditures, stimulation of, 38, 
45> 46, 59> 65, 86, 166 

Capital gains, 55, 136, 245; assessment, 
194; discrimination in form of per- 
sonal holding company, 136; exclusion 
of long-term, 238; tax, 23, 180, 194 

Capital gains taxation panel, 189 

Capital goods, 97 

Cary, William L., 98 

Case history, 214 

Cases, 2, 74, 108, 230; closed, 92, 93, 94; 
decided, 108; small number of, 30, 155, 

Cash on hand, avoidance of, 21 

Cash resources reduced, 24 

Certainty, 43, 210; impossible, 61, 209. 
See also Uncertainty 

Change of business form, 17, 19, 20, 38, 
154, 155, 168, 202 

Charitable organizations, 55, 56, 59, 202 

Chemical and drug industry, 13, 104 

Chicago, 151 

Chicago Stockyards case, 268 

Chronic desuetude, 19 

Clarity, 73, 205, 241, 263-72, 276. See 
also Formula 

Closely held corporations, 6, 26, 36, 40, 
45, 48, 49, 80, 84, 85, 114, 182, 240, 
244» 275 

Collections deferred, 49 

Commitments, 66 

Companies, expanding, 49, 126 

Compensation, 134; reasonable, 242, 286 

Committee for Economic Development, 
116, 192 

Committee on the Judiciary, 56, 67 

Computers, 122 

Concentration of industry, 21-24, 47, 50, 
67, 202 

Confidential information, fear of reveal- 
ing, 135 

Confusion, 30 

Congress, 53, 57, 97, 200, 201, 202, 205, 
240, 267, 275, 281, 285, 296 

Congressional action, 156 

Congressional hearings, 168 

Congressional intent, 165 

Congressional policy, 164, 183 

Congressman, 145; pressure by, 274 

Connecticut, 122, 123, 127, 128, 151 

Connecticut experience not typical, 128 

Connecticut light manufacturing family 
corporations, 122 

Connolly, John L., 217-18 

Constitution, 4 

Contingencies, 39 

Contingency fund: need of blind, 132; 
possibilities of abuse with blind, 133 

Contra-cyclical operations, 197 

Controllers Institute, 130 

Cooper, Walter, 70-78 

Corporations, none average, 252 
Corporations, types affected, 12, 213, 218 
Countervailing levy, 243, 245, 248, 254 
Court decisions, 5, 266; effect of, 63; lim- 
ited application in, 210 
Court of Claims, 219 
Credibility of witnesses, 60, 78 
Cuba, 134 
Curtailment of business operations, 18, 

Cyclical implications, 65 
Cyclical proposition, 68 

Dayton, Ralph, 260 

Debt, 15, 75, 124; financing, 18, 19, 20, 
39> 58, 76, 163, 167, 181, 202; retire- 
ment, 18, 19, 20, 21, 58, 86, 261, 265, 
267, 268 

Debt-free industries, 39 

Deficiency dividend credit, 220, 238, 256, 
271, 272, 295-300 

Denmark, 72 

Depreciation, 47, 151, 181, 219, 220, 241, 
286; funding, 47-48, 130; policy, 130; 
reserves, 130, 160, 181; reserves, deter- 
rent to funding of, 47 

Depressions, 98; preparing for, 51, 99 

Detroit, 151 

Directors' liability, 50, 107, 111, 115, 117, 
144, 174, 271-72 

Discontinuance of business. See Liquida- 

Dividend distribution, 22, 40, 80, 97, 
additional, 85; blamed for decline of 
New England industry, 127; credit, 
62; credit after end of year, 125, 141, 
169-70, 172, 176, 184, 238, 256, 274; 
deduction for, 62, 137; due to fear, 
215; effect on supply of equity capital, 
236; excessive, 38, 65, 66, 84, 92, 127, 
146; full details of, 200; history of, 
227; influence on, 15, 24, 48, 49, 57, 64, 
85, 102, 103, 112, 218; intercorporate, 

Dividend policy, 103, 127, 220 

Dividend record, consideration of, 133, 
226, 259, 265 

Dixon, Albert, Jr., 122-26 

Dominant stockholders, 36, 37, 54, 56, 
182; tax brackets of, 36, 216, 275, 276 

Duiker, William J., 197-203 

Dun & Bradstreet, Inc., 29 

du Pont, 160, 162 

Dutch corporations, 71 

East north central states, 9 
East south central states, 9 
Eaton, A. K., 71 n. 
Economic expansion, 58, 224 
Education, 61, 84, 171; campaign of, 
184, 271; of practitioners needed, 126 


3 11 

Effects: discriminatory, 82, see also Small 
business, discriminatory effects upon; 
diverse, 19; harmful, even if only small 
percentage affected adversely, 74, 116; 
impossible to get precise and meas- 
urable, 38; interrelated with capital 
gains and estate taxes, 23; none, 19, 
21, 95; not measured by court cases, 
30, 108, 109; proportion of corpora- 
tions affected, 10, 40, 44, 49, 98, 116, 
123, 155, 182, 196; unimportant, 87, 

Effects upon economy, 41, 59, 83, 197; 
accentuation of inflationary and defla- 
tionary trends, 38, 98-99, 165, 197, 229; 
adverse, 97, 202; harmful for future, 
98, 142; vary with business conditions, 


Electrical industry, 81 

Equity, 156, 211, 224, 254, 278, 279; and 
desirable economic effect, 232 

Equity financing, 159, 160. See also Debt 

Estate tax, 23, 55, 56, 77, 135, 166, 180 

Evidence, 3, 63, 287-93 

Excess profits tax, 4, 26, 39, 42, 44, 47, 50, 
110, 127, 282 

Excess profits tax council, 272, 273 

Exemption: by percentage of accumula- 
tion, 207, 255, 277-80; specified amount 
of accumulation, 157, 172, 173, 207, 
255, 280-82; types of corporations, 145, 
148-51, 153, 175, 200, 207, 212, 213, 
215, 217, 240, 253, 255, 259, 260, 267, 

Expansion, 17, 18, 19, 20, 25, 39, 44> 45> 
52, 58, 66, 89, 90, 124, 200, 202; cur- 
tailed, 75; doubtful, 68; encouraged, 
19, 24; influence on, 76; planning for, 
51; premature, 66, 102, 166, 180, 202; 
prevented, 75, 79; retarded, 39, 41, 53, 

75. 76-77^ 79> 123-24 
Expenditure, premature, 69, 97 
Exploration and development of new 

regions, 104 

Fact-finding panel, 10, 229 

Fallacy in section, 210 

Family corporations, 44, 122 

Fear, 24-25, 38, 39, 40, 43, 44, 49, 51, 69, 
73, 74, 80, 82, 91, 92, 98, 103, 106, 110, 
111, 125, i43» *47> !5i» !52, 165, 180, 
183, 203, 204, 212, 218, 226 

Fear, but profits retained, 17-18, 42, 91, 

92, 93» 95> 9 6 > "4» ll 5 
Federal income taxation, 3 
Financial enterprise, 13 
Flexibility, 214 
Food processing, 13 
Foreign practices, 71 
Formal commitment, 46 

Formula. See Regulations 
Fraud penalty, 221 

Funds, tendency to keep uninvested, 59 
Furniture, 13 

Future, effects on, 38, 53, 98, 142 
Gainsbrugh, Martin P., 222-26 
General Motors, 162, 234, 250 
George, Edwin B., 29-32, 187-88 
George, Senator Walter F., 62 
Germans, 53 
Glass, 12, 13 

Good faith, 133, 222, 258, 260 
Governmental advisory board, 192 
Gray, Carl A., 54 n. 
Great Britain, 7 n., 71 
Guesswork about future, 106, 168. See 
also Hindsight 

Harvard Law Review, 98 

Hawaii, 9 

Holding companies, 3, 217, 278 

Hindsight, 22, 132, 169, 257. See also 

Guesswork about future 
History, 4, 64, 201 
History of Section 102, 201 
Holmes, Justice, 207 
House of Representatives, 150, 293 
H. R. 6712, 199, 219, 237, 293 

Ignorance, 60, 68, 80, 84, 102, 103, 124, 
125, 180; does not account for fears, 

Immediacy doctrine, 40, 51, 52, 63, 89, 
123, 126, 130, 133, 165, 169, 171, 180, 
184, 203, 206, 256, 258, 259, 263, 264, 

Imminence, 121 

Income tax unit, 93 

Industries affected, 39-40 

Inflation, 42 

Inflationary effect, 102 

Inflationary periods, 58 

Inflationary spiral, 123 

Insurance brokerage, 99 

Insurance companies, 13 

Insurance, key-man, 13 

Integration of corporate and individual 
income taxes, 193, 255 

Intent, reasonableness of, 138 

Intercorporate dividend tax, 84 

Interest diminishing in 102, 222 

Internal Revenue Code, 3 

Internal review, 227, 228, 272-74 

Inventory accumulation, 45, 81, 82, 86, 


Inventories: accumulation of, forces clos- 
ing or slow down of production, 81; 
increase of, 19, 20, 202; investments in, 
123; turnover of, 40 

Invest, right to, 172, 184 

Investment, 28; funds, see Capital; in 



securities, 136; of current earnings re- 
duced, 21; purposes of, 292; retarded, 
179; speeded up, 180; stimulated, 179 

Investments: artificial, effect of stipula- 
tion on, 264; venturing of capital, 21 

Iron, 13 

Jobbing, 40 

Jobs, effect on, 19, 98, 99, 224 

Joint Committee on Internal Revenue 
Taxation, 32 

Kaiser-Fraser Automobile Company, 162 
Kaplan, A. D. H., 116 n. 
Kentucky, 12, 23 
Kurzman, Harold P., 79-81 

Labor practices, 47 

Lane Drug Company case, 241 

Large corporations, effect on, 41, 48 

Lasser, J. K., 9, 174 

Laundry, 128 

Liability set up, 66 

Life Insurance Company, 14 

Light industries, 39 

Limitation of area of challenge. See 
Application, limitation of 

Liquidation, 19, 20, 21, 22, 23, 45, 56, 
87, 202 

Liquid reserves, 42, 51, 86, 109 

Litigate, unwillingness to, 143, 165 

Litigation, bad effects of, 143, 165 

Local management, 22 

Long-profit operations, 13 

Long-range expansion program, 128, 260 

Long-range planning, 131, 229 

Long-range programs look to outside fi- 
nancing, 126 

Long-term expansion record, 265 

Long-term insurance loans, 48 

Loopholes, 61 

Machine shops, 13 

Machine tools, 109 

Magill committee, 217 

Maine, 24 

Maloney, Vincent H., 102-5 

Management decisions, 54, 103, 109, 141, 

172, 198, 219, 251, 252 
Management, function of, 5 
Manufacturing, 13, 35, 39, 41, 45 
Mature or "stagnant" economy, 224 
Medicinal research, 53 
Merchandising, 13 
Mergers, 19, 20, 21, 166, 180, 202, 260; 

stimulated, 21, 59 
Mexico, 134 
Michigan, 24, 25, 26 
Mickey, Paul, 97-100 
Middle Atlantic states, 9 
Miller, Robert N., 118 n., 142-48 
Minerals, 13 
Mining, 35 

Monopoly. See Concentration of indus- 
try, 67, 202 

Motives for accumulations, 243 

Mountain states, 9 

Mueller Macaroni Company, 252 

Myers, Paul F., 47-48 n. 

National Association of Manufacturers, 

National Grocery Company case, 64 

National Industrial Conference Board, 
188, 222 

Needle trade industry, 79, 80, 81, 82 

Net assets, 14 

New England, 9, 91, 95, 127, 128 

New products, 53, 74; development of, 
19, 20, 24, 104, 105; effect on, 21, 59; 
exploited by large rather than small 
business, 105 

New projects, 239 

New type of business, 241 

New York, 24, 41, 49, 151, 208 

New York State, 12 

New York Stock Exchange, 239-40 

New York University, 7, 8, 252 

New York University Institute on Fed- 
eral Taxation, 7, 8 

Non-liquidity, creation of, 38 

Objectives of Section 102, 105, 195, 233 
OPA, 42 

Ohio, 11, 13, 25, 26, 56 
Oil discovery and development, 106 
Oil industry, 13, 104 
Operating costs reduced, 24 
Operations curtailed, 18, 202 
Opinions in writing. See Advice on Sec- 
tion 102 
Oregon, 11, 23 
Out-of-town management, 22 

Pacific states, 9 

Paper products, 13 

Payments deferred, 81, 83 

Penalty provisions, 44 

Penalty, rarely imposed, 44 

Penalty rate, reduction of, 282-83 

Penalty, risk of, 34 

Penalty section, should be treated as, 

221, 240 
Penalty tax, 26, 221 
Pennsylvania, 11, 15, 25 
Pension and profit sharing plans, 19, 20, 

Pension benefits, 260 
Pension funds, 95 

Personal holding company, 136, 150, 275 
Personal holding company provisions, 

244, 296 
Personal service companies, 12, 13, 41, 

103, 276 
Personnel, increased perquisites for, 95, 




Petrie, J. R., 72 n. 

Philadelphia, 241 

Planning, permission for long range, 125 

Piatt, Joseph S., 83-87 

Policy panel, 170 

Politics, 156 

Political pressures, 145 

Practitioner's experience, 40 

Prediction difficulties, 83 

Prerau, Sydney, 9, 174 

Price ceilings, 39 

Price levels, 23, 46, 160 

Product development, 19 

Profits: rate of, 31; reinvestment of, 60 

Properties, acquisition of, 17, 18, 19, 20 

Proposals, digest of, 190 

Psychological factors, 30, 52, 82, 159 

Publicly held company as yardstick, 140 

Publicly held corporations, 6, 14, 39, 

130, 151, 207, 216 
Publishing, 12, 13 
Purchases, unnecessary, 45 
Purpose of Section, 154, 211, 242, 278, 


Question 8. See 70 per cent rule 
Questionable orders, 38 

Railroads, 13 

Raw materials, purchase of, 45, 49 

Reader's Digest, 54 

Real estate holding company, 161 

Reasonable needs, 3, 239; blanket rule 
for, 207 

Reasonably foreseeable needs, 202, 257, 

Recapitalizations, 260 

Receivables, 40 

Record, building up, 73 

Regulations, 26, 77, 79, 121, 122, 153, 
171, 184, 200, 202, 206, 208, 212, 213, 
220, 246, 256, 261, 262, 263-71 

Reorganization, 18 

Repeal, 60, 156, 157, 167, 168, 173, 195, 
217, 219 

Replacements: adequate, 22; costs, 200, 
241, 265; funds, 130; speeded up, 24 

Replacing of old equipment, 65 

Reserve fund, appraising need of, 114 

Reserves, 19, 200; against depression, 
100; at replacement costs, 200, 260, 
265; for unforeseen adverse develop- 
ments, 39; liquid, 101 

Retail automobile sales agencies, 13 

Retained earnings. See Accumulation 

Retained earnings, uncertainty as to use, 

Retention. See Accumulation 

Retirement of preferred stock, 34 

Revenue: as objective, 154, 156, 279; 
effect of section on, 148; indirect, 218; 

insignificant, 218 
Review. See Internal review 
Revenue Acts: 1913, 4, 279; 1916, 201; 

1921, 4; 1938, 201 
Rez, Arthur, 72 n. 
Risk capital. See Capital, risk 
Rudick, Harry J., 58-61 
Rulings, 200, 260, 265, 269 

Salaries, 159, 220; effect on, 18, 19, 85 
Sales of businesses, 19, 20, 22, 23, 45, 46, 

47> 55. 56, 57> 59> 8 7> 97> 10 5> V 2 ' l8o > 
202; combined effect of Section 102 
and estate tax on, 77 

San Francisco, 208 

Saturday Evening Post, 54 n. 

Schram, Emil, 239 

Screw machine products, 122 

Section 102: importance of, 5; ineffective 
in producing distributions, 60, 232, 
234; might be more stringent, 232, 
234, 235, 236; necessary, 61, 117, 125; 
necessary for some corporations, but 
injurious to others, 145; purpose of, 97 

Section 115 (g) case, 134, 269 

Section 722, 270 

Securities, deterrent to sale of, 136 

Security dealers, 13 

Seidman, J. S., 197 

Senate, 150, 201 

Service companies, 35, 40 

70 per cent rule, 4, 5, 26, 39, 44, 49, 67, 
85, 92, 98, 101, 108, 109, 120, 121, 124, 
158, 171 n., 207, 224, 265, 290 

Shift from local to foreign enterprise, 47 

Shipments, held up, 82 

Sibley, George, 52-55 

Silverson, Harry, 134-36 

Simons, Henry, 194 

Sixteenth Amendment, 4 

Slitor, Richard E., 231-32 

Small business, 22, 37, 39, 41, 44» 47» 5°' 
53, 60, 68, 100, 101, 102, 104, 105, 106, 
116, 124, 150, 224, 225, 231; difficulty of 
in getting capital, 92; discriminatory 
effects upon, 22, 52, 67, 93, 105, 116, 
140, 162, 201; grows by retaining earn- 
ings, 115; needs reserves, 101, 149; par- 
ticular effect on, 80; special considera- 
tion for, 265 

Small Business Advisory Committee of 
Department of Commerce, 171 n. 

Small Business Committee, 60 

Small stockholder, concern for, 117 

Smith, Dan Throop, 164-67 

Smith, S. Abbot, 91-95 

Social motivation, 253 

Sonderman, L. H., 237-40 

South Carolina, 12 

South Central States, 9 

Spendings tax, 254 



Stam, Colin, 32, 35 

Statistical study suggested, 103 

Statute of limitations, 131; longer, 132, 

Steel, 13 

Steel company, 82 

Steele's Mills v. Robertson, 48 n. 

Stock, disposal of, 18 

Stock dividends, issuance of, 18, 45, 58 

Stock market, 58 

Stockholder pressure, 54, 85, 251 

Stockholders' approval, 172 

Stockholders' desire for investment, 74 

Stockholders, number of, 14, 35 

Stockholders' suits, 50, 117, 119; more 
feared than 102 penalty, 117. See also 
Directors' liability 

Stockholders, unjust to individual, 249 

Stockholdings, distribution of, 41 

Subsidiaries, 15, 78, 79, 84, 112-13; ac- 
quisition of, without penalty, 160 

Surplus, illusory, 22, 75, 139 

Surtax, 57, 247; avoidance of, 3, 51, 98, 
101, 153, 155, 201, 279; ceiling, 156; 
rates, 17, 102, 248. See also Tax Avoid- 

Surtax rates and retention of dividends, 
15, 17, 19, 24, 60, 61, 85 

Sweden, 71 

Tariff Act of 1915, 201 

Tarleau, Thomas N., 191 

Taxation Institute of Australia, 71 n. 

Tax avoidance, 63, 168, 234. See also 
Surtax, avoidance of 

Tax Court, 51, 60, 93, 94, 98, 99, 100, 
109, 124, 133, 134, 135. HL 142, i55> 
165, 170, 204, 205, 209, 219, 272, 284, 

Tax-exempt organizations, 55 

Tax Institute, Inc., 3, 6, 7, 8, 22, 28, 29, 
31. 32, 33' 55' 7 1 n -> l6 2> 187, 188, 189, 
194; Panel Committee, 9, 174 

Tax motives, 243 

Tax structure, re-examination of, 194; 
reform of, 61 

Tax system, overhauling, 57, 173 

Teeth in law, 205, 287 

Tennessee, 12 

Textile industry, 12, 13, 42, 45, 46, 57, 
64, 65, 66, 81, 82, 139, 140, 160, 182 

"Thin incorporation," 163 

Tie-in stock purchase, 162 

Timing: of capital expenditures, 165; of 
dividend distributions, 165; of expan- 
sion, 104; of increases in inventory, 

Timing leeway, 238, 274-75 

Trade groups, 13 

Trico Products Corporation, 17, 18, 25, 

35, 50, 111, 112, 119, 120, 174, 216, 

238, 276, 277 
T. D. 4914, CB 1939-2, 5 
Trust companies, 13 
Turner, C. L., 64-67 
Turnover, 80 
Typewriters, 122 

Uncertainty, 43, 63, 153, 180, 206, 211, 
212, 213, 214, 215, 220, 229, 230, 265, 
Undesirable business policies, 44, 45 
Undistributed profits tax, 62, 64, 193, 

233, 236, 249, 251 
United Kingdom, 70, 72 n. 
United States, 25, 49, 52, 128, 148, 230 
U. S. Chamber of Commerce, 292 
United States District Court for North 

Carolina, 48 n. 
U. S. Rubber, 162 
U. S. Steel, 12, 233 
Unneutrality of tax laws, 195, 233 
Unpredictability and fortuitous inci- 
dence, 108 
Unrelated business purchased, 162 
Unsound business practices, 49 

Vandeveer, W. W., 56 

Variations among stockholders with re- 
spect to holdings and income tax 
brackets, 251, 252 

Vickrey, William, 242-46 

Violation, continued, 200 

Vulnerability, 35, 163 

Wage increases, 57 

Wallpaper factory, 91 

Washington, D. C, 21, 24 

Weapon, 55 

Weapon for planners, 53 

Wesley an University, 28 

West north central states, 9 

West south central states, 9 

Window-dressing devices, 59, 86, 131 

World Broadcasting decision, 77 

World Publishing Company case, 63, 

209, 254, 257, 259 
World War II, 22, 23, 49, 122 
Worry, 96 

Year-end position, consideration of, 86, 

113, 114 
Year under examination, 200 

Date Due 


^- - 

. 0)p' 1 9 









Economic effects of Section 10 main 
658.1 71 2T235e 

3 12b2 Q3Sn a 540